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LIBRARY 

UNivEF:!;r:Y  of 

CA'jrORMA 

SAM  Bl&QO 


^ 


f  LIBRARY 
UNIVLu.m'.  ..  U.L.i-ORNIA,  SAN  DIEGG 
LA  JOLLA.  CALIFORNIA 


3   1822  01'168  1046 


High  Prices  and  Deflation 


HIQ^H  PRICES 

AND     DEFLATIOlSr 


BY 

EDWIN  WALTER  KEMMERER 

Professor  of  Economics  and  Financfein  Princeton  University; 

Author  of  The  A  B  C  of  the  Federal  Reserve  System, 

Modem  Currency  Reforms,  Etc. 


With  an  Introduction  by 

FRANK  A.  VANDERLIP 


PRINCETON   UNIVERSITY  PRESS 

LONDON  :  HUMPHREY  MILFORD 
OXFORD  UNIVERSITY  PRESS 

1920 


Copyright  1920,  by 

Princeton  University  Press 

Princeton,  N.  J. 


Published    1920 
Printed  in  the  United  States  of  America 


PREFATORY  NOTE 

This  book  represents  a  revision  and  enlarge- 
ment of  three  articles  published  during  the 
winter  of  1919-1920  by  the  Bankers'  Statistics 
Corporation  of  New  York  City.  The  subjects 
of  the  three  articles  were  respectively  Infla- 
tion, High  Prices,  and  Deflation.  In  view  of 
the  widespread  interest  shown  in  the  articles, 
and  of  the  receipt  of  numerous  requests  for 
copies  of  them,  I  have  revised  them  for  pub- 
lication in  book  form.  The  Bankers'  Statistics 
Corporation  has  kindly  consented  to  this  re- 
publication. 


INTRODUCTION. 

The  six  years  from  1913  to  1919  are  striking 
ones  from  many  points  of  view.  During  this 
period  we  saw  the  fires  of  the  world's  greatest 
war  smolder,  break  into  flames  and  die  away 
again;  we  witnessed  the  overthrow  of  great 
nations  and  the  repartition  of  Europe  along 
new  lines;  countries  which  had  not  existed 
prior  to  1913  as  national  units  sprang  into 
being  and  vast  armies  of  men  were  drawn  from 
factories,  desks  and  fields,  trained  and  sent  to 
battle  from  which  many  never  returned.  Coin- 
cident with  these  changes,  problems  of  the  first 
importance  have  developed  in  our  economic 
life,  problems  which  affect  each  of  us  to-day  in 
a  very  vital  manner  and  which  demand  intelh- 
gent  study  and  correct  solution.  Chief  among 
these  problems  is  that  of  the  high  cost  of  li\'ing, 
its  causes  and  effects,  and  the  question  of  what 
is  to  be  done  to  relieve  the  situation  as  it  now 
exists.  An  enlightened  public  opinion  on  this 
whole  subject  is  an  urgent  national  need. 

The  increase  in  general  prices  throughout 
the  world  is  the  outstanding  economic  phe- 
nomenon of  the  period  included  between  1913 
and  1919.  In  Australasia  that  rise  was  about 
100  per  cent;  in  countries  having  a  gold  stand- 

(vii) 


ard  still,  such  as  the  Scandinavian  nations, 
Japan  and  the  United  States,  it  has  varied 
from  150  per  cent  to  250  per  cent,  while 
in  paper  money  countries,  like  Russia  and 
Austria,  it  has  mounted  to  several  thousand 
per  cent. 

It  is  evident  that  when  the  price  level  in- 
creases, the  value  of  the  dollar  declines.  To 
double  the  price  level  is  to  cut  the  dollar  in 
half.  Inflation,  followed  by  the  inevitable 
depreciation  of  money,  has  varied  during  these 
six  years  in  different  countries.  Even  in  the 
same  country  different  kinds  of  prices,  as,  for 
example,  wholesale  prices,  retail  prices,  wages 
and  prices  for  public  services  responded  with 
different  degrees  of  promptness  and  at  differ- 
ent rates  to  inflationary  forces.  The  same 
thing  may  be  said  of  the  various  commodities 
within  each  of  these  groups. 

The  ever-present  question  of  the  "profiteer" 
can  be  traced  back  to  the  changing  extents  and 
varying  degrees  of  promptness  to  which  whole- 
sale and  retail  prices,  respectively,  have  re- 
sponded to  the  forces  of  inflation.  The  reason 
for  the  high  cost  of  living  and  for  industrial 
disturbances,  if  tracked  down,  will  lead  back 
largely  to  the  same  cause.  Increase  in  wages 
has  not  followed  closely  enough  the  increase  in 


IX 


price  level,  and  the  labor  problem  has  thus 
continued  to  be  a  very  troublesome  one.  Fixed 
or  slowly  rising  rates  for  railroads  and  other 
public  utilities  under  governmental  control 
have  not  kept  pace  with  the  enormous  rise  in 
the  costs  of  materials  and  services.  The  result 
has  been  retarded  development  of  our  trans- 
portation and  transmission  systems. 

The  true  value  of  savings  accounts  has  been 
cut  in  half  by  the  rapidly  depreciating  dollar, 
and  the  same  is  true  of  paid-up  insurance 
policies,  of  fixed  incomes  from  bonds,  mort- 
gages, pensions  and  preferred  stocks.  Chief 
among  the  sufferers  have  been  those  who  least 
deserved  to  be  exploited — colleges,  universities, 
benevolent  institutions,  and  the  thrifty  people 
who  in  the  past  saved  capital  and  put  it  to 
some  productive  use.  All  these  have  been 
penalized,  and  the  newly  rich,  with  extravagant 
spending  tendencies,  have  watched  gold  pour 
into  their  purses.  Teachers,  clerks  and  others 
with  fixed  salaries  have  been  hard  hit.  On  the 
other  hand,  the  facility  with  which  money  could 
be  borrowed,  owing  to  the  low  rate  of  interest 
demanded,  led  to  dangerous  speculation  and 
shameless  extravagance.  Widespread  discon- 
tent and  extreme  radicalism  have  resulted. 


In  this  book  High  Prices  and  Deflation, 
Professor  Kemmerer  explains  the  process  of 
inflation  and  the  rise  in  the  cost  of  hving  since 
1913,  examines  the  degree  of  inflation  and  con- 
siders the  economic  and  social  results  flowing 
from  it.  He  shows  why  prices  must  ultimately 
come  down  and  points  out  the  policy  to  be 
pursued  in  order  to  bring  about  deflation. 
There  are  no  more  important  questions  de- 
manding our  attention  to-day  than  these,  and 
an  effort  to  put  them  squarely  before  the  public 
in  a  simple,  clear  and  concise  manner  is  worthy 
of  the  highest  praise  and  the  greatest  success. 
Professor  Kemmerer's  book  is  a  most  useful 
contribution  to  a  very  vital  subject. 

Frank  A.  Vanderlip. 

"Beechwood," 
Scarborough-on-Hudson, 
New  York, 
August  i8,  1920. 


CONTENTS. 


Page 

Prefatory  Note  v 

Introduction.    By  Frank  A.  Vanderlip vii 

CHAPTER  I. 
Inflation  3-30 

Scope  of  book,  3.  Inflation  defined,  3-4.  Kinds  of 
inflation,  4-5.  Annual  growth  of  physical  volume  of 
business,  1913-1919,  measured,  5-9.  Monetary  cir- 
culation of  U.  S.,  annual,  1913-1919,  10-13.  Heavy 
imports  of  gold  from  Europe  and  impounding  of 
gold  by  federal  reserve  banks,  13-14.  Reduction  in 
legal  reserve  requirements,  14-17.  "Taking  up  the 
slack,"  18.  Banks  found  it  profitable  to  expand  loans 
and  deposits,  18-22.  Bankers  considered  it  their 
patriotic  duty  to  expand  loans  and  deposits,  22.  Busi- 
ness men  and  public  considered  it  their  patriotic  duty 
to  borrow  heavily  of  banks  in  order  to  extend  busi- 
ness and  to  buy  Liberty  bonds,  22-23.  Government, 
to  obtain  funds  for  financing  the  war,  encouraged 
loan  and  deposit  expansion  by  a  policy  of  low  dis- 
count rates  at  federal  reserve  banks,  23-26.  Drain 
of  gold  prevented  by  gold  embargo,  26.  Expansion 
of  bank  deposits,  1913-1919,  26-28.  Reduction  of 
ultimate  bank  reserves,  28-29.    Rise  of  prices,  30. 

CHAi'TER  II. 
High  Prices   31-54 

Without  inflation  the  prices  of  commodities  greatly 
needed  for  war  would  have  risen,  33-34.  Extent  of 
rise  in  wholesale  prices  as  shown  by  different  index 
numbers,  35.  Depreciation  of  gold  dollar  during 
period  of  1913  to  1919  compared  with  that  of  Bank 


xu 

Page 
of  England  notes  during  Napoleonic  Wars  and  that 
of  greenbacks  during  Civil  War,  36-38.  Prices  of 
nearly  all  classes  of  commodities  advanced  greatly, 
38-40.  Not  high  prices  but  rising  prices  the  evil, 
40-41.  Effects  of  rising  prices  on  contractual  rela- 
tions between  debtors  and  creditors,  41-44.  Varying 
degrees  of  responsiveness  of  dififerent  kinds  of  prices 
and  of  prices  of  different  kinds  of  goods,  45-47. 
Wage  increases  very  uneven,  47-51.  Rising  prices  the 
most  important  single  cause  of  present  widespread 
discontent,  51-52.  Inflation  helped  finance  the  war, 
but  distributed  very  inequitably  the  war's  economic 
burden,  52-53.  Conclusions  of  chapter  summarized, 
53-54. 

CHAPTER  III. 
Deflation    55-82 

Inflation  as  a  permanent  policy  in  time  of  peace 
impossible,  57-58.  Evils  of  deflation  summarized, 
58.  Deflation  causes  injustice  to  debtor  classes  and 
to  holders  of  rights  to  fixed  money  incomes,  59-61. 
Deflation  depresses  business,  61-62.  Deflation  causes 
unemployment,  reduces  wages,  and  weakens  the  hold 
of  trade  unions  on  their  members.  62-63.  Deflation 
is  necessary  because  gold  supply  is  inadequate  to 
maintain  present  high  price  levels  on  a  stable  gold- 
standard  basis,  63-69.  Deflation  if  brought  about 
promptly  would  eliminate  or  mitigate  some  of  the 
evils  of  inflation,  69-70.  Deflation  to  pre-war  price 
level  not  necessary,  71-75.  Means  of  bringing  about 
deflation,  75-82.  High  discount  rates  on  part  of 
federal  reserve  banks,  76-78.  Possibly  higher  inter- 
est rates  on  government  war  debt,  78-79.  Discrim- 
ination on  part  of  federal  reserve  banks  in  making 
loans,  79.  Other  means  of  bringing  about  deflation, 
79-81.  Conclusions  of  chapter  summarized,  81-82. 
Index   83 


CHAPTER  I— INFLATION 


High  Prices  and  Deflation 


CHAPTER  I 

INFLATION 

To  what  extent  and  why  has  the  leve]  of 
prices  in  the  United  States  risen  during  the 
past  seven  years?  What  are  the  chief  eco- 
nomic results  of  this  high  and  rising  price 
level?  Will  the  price  level  decline  in  the  near 
future,  and  if  so  what  forces  will  work  to  bring 
about  the  decline?  The  subjects  suggested  by 
these  three  questions  may  be  briefly  designated 
by  the  terms  Inflation,  High  Prices,  and  De- 
ftaiion — the  subjects  of  the  three  chapters  of 
this  book. 

Although  the  term  inflation  in  current  dis- 
cussions is  used  in  a  variety  of  meanings,  there 
is  one  idea  common  to  most  uses  of  the  word, 
namely,  the  idea  of  a  supply  of  circulating 
media  in  excess  of  trade  needs.  In  a  previous 
article^  by  the  writer,  upon  whose  detailed 
statistics  revised  and  extended  to  date  many 
of  the  conclusions  in  the  present  chapter  are 
based,    inflation    was    described   as    occurring 


Mnflation:    The  American  Economic  Review,  June,  1918, 
pp.  247-269. 

3 


"when,  at  a  given  price  level,  a  country's  circu- 
lating media — money  and  deposit  currency — 
increase  relatively  to  trade  needs."  The  value 
of  money,  like  the  value  of  every  other  com- 
modity, is  the  resultant  of  the  interaction  of 
the  forces  of  demand  and  supply.  An  increase 
in  the  circulating  media  (i.  e.,  money,  and 
deposit  currency  supported  by  money  in  bank 
reserve)  relative  to  trade  needs  tends  to  make 
the  monetary  unit  depreciate,  in  other  words, 
to  force  down  the  purchasing  power  or  the 
market  value  of  the  dollar. 

There  are  two  kinds  of  depreciation — spe- 
cific depreciation  and  general  depreciation. 
Specific  depreciation  occurs  when  one  or  more 
kinds  of  exchange  media  are  issued  in  such 
relative  excess  that  they  depreciate  in  terms  of 
the  legal  standard-money  unit.  Good  exam- 
ples of  specific  depreciation  are  found  in  the 
United  States  greenbacks  from  1863  to  the 
end  of  1878,  and  in  the  notes  of  the  Bank  of 
England  during  the  period  of  suspension  of 
specie  payments  from  1797  to  1821.  General 
depreciation  occurs  when  excessive  issues  of 
money,  or  of  deposit  currency  which  circulates 
in  the  form  of  checks,  result  in  the  depreciation 
of  the  legal  standard-money  unit  itself.  Ex- 
amples of  general  depreciation  are  found  in 


England  during  the  years  immediately  follow- 
ing the  Australian  and  Californian  gold  dis- 
coveries and  in  all  gold  standard  countries 
from  1896  to  1913.  In  these  cases  gold  itself 
depreciated  and  the  prices  of  most  goods  in 
terms  of  gold  standard  money  rose.  Obvi- 
ously, general  depreciation  may  exist  either 
with  or  without  specific  depreciation. 

The  United  States  since  1913  has  had  gen- 
eral depreciation,  but  fortunately  has  escaped 
specific  depreciation,^  for  all  forms  of  United 
States  money  and  deposit  currency  have  been 
maintained  at  par  with  the  standard  gold  unit 
of  value.  The  monetaiy  depreciation  we  have 
had  has  not  been  a  depreciation  of  paper 
money  or  of  deposit  currency  in  terms  of  gold, 
but  a  depreciation  of  our  gold  monetary  unit 
itself,  and  of  all  other  kinds  of  exchange  media 
whose  values  have  moved  with  that  of  gold. 

In  attempting  to  form  a  judgment  as  to  the 
extent  to  which  our  circulating  media  have 
been  inflated  since  1913,  the  first  problem  is 
to  measure  in  some  way  the  growth,  since  that 
date,  of  the  country's  physical  volume  of  busi- 
ness.   Money  and  circulating  bank  credit  exist 


*  During  the  latter  days  of  the  war  it  was  reported  that 
a  slight  premiam  on  gold  appeared  in  a  few  transactions 
In  some  parts  of  the  United  States.    It  rapidly  disappeared. 


primarily  as  instruments  for  exchanging  goods 
and  services.  This  exchange  work  is  their  job. 
To  what  extent,  if  any,  has  the  job  increased 
during  the  last  six  years?  This  question  can- 
not be  answered  with  any  high  degree  of 
accuracy,  but  a  rough  approximation  can  be 
reached  through  the  study  of  certain  business 
statistics  which  typify  business  activity  and 
growth.  Obviously  the  statistics  used  for  this 
purpose  should  be  statistics  of  physical  quan- 
tity and  not  of  value  involving  prices,  since 
movements  of  the  price  level  are  one  of  the 
results  of  inflation. 

Among  the  best  items  for  measuring  the 
movement  of  business  in  general,  because  they 
are  items  that  enter  into  so  many  products, 
are  the  production  of  pig  iron,  bituminous  coal, 
anthracite  coal,  petroleum,  copper,  and  silver. 
Other  goods  indices  of  general  business  are  the 
number  of  tons  of  freight  carried  on  important 
railroads  and  the  tonnage  of  vessels  entered 
and  cleared  at  American  ports.  Representa- 
tive of  agricultural  industry  is  the  production 
of  wheat,  corn,  and  cotton ;  and  representative 
of  the  building  industry  is  the  number  of  build- 
ing permits  given  in  leading  cities.  Here  are 
twelve  items,  any  one  of  which  is  an  honest 
witness  of  the  growth  of  American  business, 


7 

but  each  of  which  has  its  own  bias.  Safer  than 
to  trust  any  one  of  them  is  to  take  the  testi- 
mony of  all,  so  that  in  the  mouths  of  many 
witnesses  the  truth  may  be  established. 

If  we  reduce  the  figures  of  these  twelve 
items  to  a  percentage  basis,  taking  as  100  the 
figure  for  the  j^ear  1913,  and  if  we  then  com- 
bine these  figures  into  a  simple  average,  we 
arrive  at  the  following  series  of  index  numbers^ 
which  represent  in  a  rough  way  the  growth  of 
the  country's  physical  volume  of  business  since 
1913. 

1913  100 

1914  99 

1915 104 

1916 109 

1917  112 

1918 113 

Most  of  the  data  used  in  the  computation 
of  the  above  series  of  index  numbers  are  not 
available  for  the  year  1919.  Fortunately,  hov/- 
ever,  we  have  in  the  figures  relating  to  the 
"physical  volume  of  trade"  now  being  pub- 
lished every  month  in  the  Federal  Reserve 
Bulletin  data  for  a  considerable  number  of 
items  that  are  useful  indices  of  business 
growth.      Selecting    the    more    important    of 


'  For  a  fuller  description  of  the  items  entering  into  these 
index  numbers,  see  E.  W.  Kemmerer,  Inflation,  American 
Economic  Review,  June,  1918,  p.  248,  note  1. 


these  items,  for  which  figures  are  available  for 
the  years  1918  and  1919,  thirteen  in  number, 
and  comparing  the  figures  for  1918  (which  are 
taken  as  100)  with  those  of  1919,  we  arrive  at 
the  following  result: 

(1)  Tonnage  of  vessels  cleared  in  foreign  trade,  . . .   113.6 

(2)  Total   freight   carried   on   canals   at   Sault   Ste. 

Marie,    79.7 

(3)  Bituminous  coal,  estimated  production,  78.2 

(4)  Anthracite  coal,  estimated  production,   87.2 

(5)  Total  output  of  gasoline,   110.9 

(6)  Pig  iron  production,   79.4 

(7)  Steel  ingot  production  (8  months  only),   86.2 

(8)  Lumber  shipment  (southern  pine,  western  pine, 

Duglas  fir,  eastern  white  pine,  and  North  Caro- 
lina pine) 97.0 

(9)  Receipts  and  shipments  of  cattle  of  all  kinds  at 

15  western  markets,   104.3 

(10)  Cotton  consumption  in  the  United  States 95.7 

(11)  Cotton  spindles  active,   101.1 

(12)  Wool  consumption  in  the  United  States,   89.7 

(13)  Imports  of  raw  silk,  137.5 

Average  of  all  13  items,   97.0 

The  physical  volume  of  business  done  in  the 
United  States  in  1919  as  evidenced  by  the 
above  figures  was  therefore  3  per  cent  less  than 
that  for  1918.  This  percentage  decline  in  1919 
as  compared  with  1918  would  give  an  index 
number  of  109.6  (in  the  table  on  page  7)  for 
the  physical  volume  of  business  done  in  1919 — 


9 

an  index  number  that  is  only  about  one-half  of 
one  per  cent  less  than  that  for  1916/ 

Such  a  decrease  in  1919  is  not  surprising, 
when  one  thinks  of  the  decline  in  all  kinds  of 
war  industry  after  the  armistice,  the  inliibiting 
influences  brought  about  by  the  process  of  re- 
absorbing millions  of  fighting  men  in  economic 
activities,  the  transfer  of  millions  of  others 
from  war  time  industries  to  industries  of  peace, 
and  the  large  number  of  labor  disturbances 
that  characterized  the  year  1919. 

^Vith  a  price  level  unchanged,  a  given  phys- 
ical volume  of  business  could  probably  have 
been  carried  on  under  the  war  conditions  pre- 
vailing in  the  United  States  during  the  years 
1917  and  1918,  with  a  smaller  amount  of 
money  and  circulating  credit  than  in  normal 

*  Professor  Wesley  C.  Mitchell  has  computed  a  series  of 
index  numbers  for  the  years  1913  to  1918  of  the  physical 
volume  of  business  by  taking  the  yearly  production  of  "90 
raw  materials,  including  substantially  all  the  great  staples 
and  a  few  rather  trifling  imported  commodities,"  weighting 
them  at  the  prices  of  1917.  His  results  are  very  similar  to 
those  I  have  arrived  at  above  by  an  entirely  different 
method.    Mitchell's  figures  are  as  follows: 

1913    100 

1914    99 

1915  107 

1916  Ill 

1917  114 

1918  116 

History  of  Prices  During  the  War.  Summary.  War  In- 
dustries Board,  pp.  44,  45. 


10 

times,  because  the  shifting  of  production  to 
government  account  shortened  greatly  tlie 
average  distance  from  producer  to  consumer, 
and  lessened  the  average  amount  of  exchange 
or  money  work  required  to  place  a  given 
amount  of  goods  in  the  hands  of  the  final  con- 
sumer. On  this  subject  Professor  G.  O. 
Virtue  said  in  a  recent  article:^  "the  effect  of 
this  large-scale  purchase  by  the  govermnent, 
often  in  the  early  stages  of  production,  and  its 
method  of  dispensing  them  v.ithout  further  use 
of  money,  by  decreasing  the  rapidity  of  circu- 
lation of  great  quantities  of  goods,  must  have 
affected  the  price  level  in  the  same  way  as 
would  a  reduction  in  the  amount  of  goods,  or 
a  sudden  resort  to  barter  on  a  larger  scale,  or 
to  a  more  direct  move  of  marketing." 

Let  us  now  turn  from  the  demand  for  money 
and  deposit  currencj^  to  the  supply.  The  term 
*'money  in  circulation"  is  one  that  is  used  to 
cover  a  variety  of  different  meanings,  but  one 
of  the  commonest  meanings,  and,  for  the  pur- 
poses of  a  study  of  inflation  for  the  period  of 
1913  to  1919,  the  most  satisfactory  one,  is  to 
make  it  cover  all  money  in  active  circulation, 
namely  in  the  pockets  of  the  people  and  the 


'  Another    Reason    Why    War    Prices    are    High    Prices. 
Quarterly  Journal  of  Economics,  August,  1919,  pp.  729-733. 


11 

tills  of  merchants  and  all  money  in  the  reserves 
of  banks — actual  cash  reserves,  not  legal  re- 
serves— except  such  a  part  of  that  held  by 
federal  reserve  banks  as  may  properly  be  allo- 
cated as  reserve  for  federal  reserve  notes. 
If  the  federal  reserve  notes  are  counted  as 
money  in  circulation,  as  I  believe  they  should 
be,  then  the  cash  reserve  held  against  tliese 
notes  obviously  should  not  be  counted  as  in 
circulation.  On  the  other  hand  cash  reserves 
held  in  banks  against  deposits  are  usually  con- 
sidered as  money  in  circulation.  If  such  cash 
reserves,  in  the  vaults  of  individual  banks,  serv- 
ing as  the  support  of  bank  deposits  are  to  be 
considered  as  in  circulation  for  the  years  prior 
to  the  complete  establishment  of  the  federal 
reserve  system,  the  cash  reserves  now  held  by 
federal  reserve  banks  against  deposits  of  mem- 
ber banks,  cash  reserves  which  now  perform 
indirectly  the  greater  part  of  the  cash  reserve 
function  formerly  performed  for  the  present 
member  banks  by  "cash  on  hand,"  such  cash 
reserves  in  federal  reserve  banks  should  now 
be  counted  as  money  in  circulation.  It  is  mis- 
leading to  adopt  the  practice  followed  by  some 
writers,  of  counting  cash  reserves  (i.  e.,  actual 
cash  on  hand)  in  national  banks  as  "money  in 
circulation"    before   the   inauguration   of   the 


12 

federal  reserve  system  and  to  exclude  from 
"money  in  circulation"  since  that  time  the  re- 
serves held  by  federal  reserve  banks  against 
deposits — reserves  which  in  the  main  perform 
the  same  function,  though  indirectly,  that  the 
cash  reserves  of  individual  banks  previously 
performed. 

Interpreting  the  words  "money  in  circula- 
tion" in  the  manner  above  described,  allocat- 
ing the  same  percentage  of  reserve  to  federal 
reserve  notes  and  to  federal  reserve  deposits, 
and  taking  the  average  figures  for  four  quar- 
terly dates  of  each  year  as  the  figure  for  the 
year,  we  arrive  at  the  following  table  for  the 
monetary  circulation  of  the  United  States : 

MONETARY    CIRCULATION. 

Amount  of  Money      Index 

Year  in  Circulation^  Number 

(Millions) 

1913    $3,390  100 

1914  3,505  103 

1915  3,682  109 

1916  4,159  123 

1917  4,914  145 

1918  5,579  165 

1919  5,793  171 

'  In  computing  the  total  monetary  circulation  of  the 
United  States,  the  following  plan  has  been  used.  In  order 
to  make  the  figures  representative  of  the  entire  year,  and 
render  them  comparable  with  those  for  the  growth  of 
business,  we  have  taken  for  each  year  the  average  of  the 


18 

From  1913  to  1919  the  amount  of  money  in 
circulation  therefore  increased  71  per  cent, 
while  the  physical  volume  of  business  increased 
9.6  per  cent. 

Two  important  items  in  this  great  increase 
in  the  monetary  circulation  were :  ( 1 )  the  heavy 
net  imports  of  gold  from  Europe  resulting 
from  our  large  exports  of  war  materials  to  the 
belligerent  countries,  and  (2)  the  policy  of  the 
federal  reserve  authorities  of  withdrawing  gold 
certificates  and  gold  coin  from  active  circula- 
tion, and  substituting  therefor  so  far  as  pos- 
sible federal  reserve  notes,  thereby  substituting 
for  money  representing  100  per  cent  gold  a 
form  of  money  which  required  only  a  legal 
gold   reserve    of    40    per    cent.      The   period 


circulation  figures  for  the  four  quarterly  dates,  beginning 
with  that  of  March  31. 

The  circulation  includes  all  kinds  of  money  in  the 
country,  except  that  held  in  the  federal  treasury  as  assets 
of  the  government,  and  except  that  part  of  the  cash  held 
by  the  twelve  federal  reserve  banks  and  the  twelve  federal 
resen^e  agents,  that  would  represent  the  same  percentage 
of  cash  reserve  against  outstanding  federal  reserve  notes 
as  the  percentage  held  against  deposits  and  notes  com- 
bined. Only  net  circulation  of  federal  reserve  notes  is 
therefore  included  in  the  circulation,  but  the  net  circula- 
tion is  computed  on  the  basis  of  allocating  to  the  notes  the 
same  percentage  of  reserve  as  that  represented  by  the 
percentage  of  cash  reserve  held  by  the  federal  reserve 
banks  to  deposits  and  outstanding  notes  combined.  In 
this  way  the  figures  for  the  period  before  the  federal 
reserve  amendment  of  June  21,  1917,  are  made  comparable 
with  those  after  that  date. 


14 

studied  witnessed  a  very  large  expansion  of 
federal  reserve  notes.  In  1913  there  were  no 
federal  reserve  notes,  and  on  November  7, 
1919,  there  were  $2.8  billions  of  federal  reserve 
notes  in  circulation  against  which  a  reserve  of 
45.3  per  cent  was  held,  giving  a  net  circulation 
uncovered  by  gold  of  $1.5  billions.  At  the 
present  writing  (March  26,  1920)  the  circula- 
tion of  federal  reserve  notes  is  $3,048  millions 
against  which  a  reserve  of  40.1  per  cent  is  held, 
giving  a  circulation  uncovered  by  gold  of 
$1,826  millions. 

The  period  1913  to  1919  was  a  period  in 
which  the  country's  legal  reserve  requirements 
for  bank  deposits  were  enormously  reduced. 
In  1913  national  banks  in  central  reserve  cities, 
namel}^  New  Yo-rk,  Chicago  and  St.  Louis, 
were  required  to  keep  on  hand  cash  reserves 
equivalent  to  25  per  cent  of  their  deposits,  both 
demand  deposits  and  time  deposits.  National 
banks  in  the  47  reserve  cities  were  also  required 
to  maintain  reserves  of  25  per  cent,  but  one- 
half  of  this  could  be  maintained  as  an  ordinary 
deposit  with  a  national  bank  in  a  central 
reserve  city.  Other  national  banks,  so  called 
"country  banks"  were  required  to  maintain 
against  deposits  reserves  of  15  per  cent  of 
which  three-fifths  could  be  held  as  an  ordinary 


15 

deposit  with  a  national  bank  in  a  reserve  city 
or  a  central  reserve  city.  For  all  banks  the  5 
per  cent  cash  redemption  fund  held  at  Wash- 
ington against  outstanding  bank  notes  was 
counted  as  part  of  the  legal  reserves  against 
deposits. 

At  the  present  time  all  legal  reserves  of 
national  banks  consist  of  deposits  with  fed- 
eral reserve  banks  against  which  deposits  the 
federal  reserve  banks  are  required  to  main- 
tain only  a  35  per  cent  lawful  money  reserve. 
Time  deposits,  namely  deposits  payable  after 
notice  of  30  days,  which  constitute  about 
one-fourth  of  the  total  individual  deposits  of 
national  banks,  since  1913  have  been  treated 
separately  as  regards  legal  reserves  and  in  all 
national  banks  are  now  subject  to  a  reserve 
requirement  of  only  3  per  cent.  The  .5  per 
cent  bank  note  redemption  fund  can  no  longer 
be  counted  as  legal  reserve  against  deposits. 
Against  demand  deposits  the  present  legal 
reserve  requirement  is  13  per  cent  for  banks  in 
central  reserve  cities,  10  per  cent  for  banks  in 
reserve  cities  and  7  per  cent  for  banks  in  other 
cities.^  Certain  minor  changes  in  legal  reserves 


'  An  amendment,  approved  June  21,  1917,  to  the  federal 
Teserve  act,  provided  that  a  central  reserve  city  bank  or  a 
reserve  city  bank  if  located  in  the  outlying  districts  of  such 
a  city  or  in  a  territory  adjoining  to  such  a  city  by   the 


16 

have  also  been  made  since  1913,  as  for  example 
those  relating  to  "the  float"  and  to  reserves 
against  United  States  Government  deposits, 
but  the  changes  above  mentioned  are  the  prin- 
cipal ones. 

An  idea  of  the  extent  of  the  reductions  in 
legal  reserves  of  national  banks  since  1913 
can  be  obtained  by  assuming  three  national 
banks,  each  having  $1,200,000  demand  de- 
posits, $300,000  of  time  deposits,  and  $100,000 
of  national  bank  notes  outstanding,  one  bank 
being  in  a  central  reserve  city,  one  in  a  reserve 
city,  and  one  in  a  "country  bank"  city,  and  ask- 
ing ourselves  what  ultimate  legal  cash  reserves 
would  have  been  held  against  these  deposits  in 
1913  and  in  1920  respectively.  The  answer 
is  given  in  the  following  table: 

1913  1920 

Per  Per 

Bank.  Cent.     Amount.       Cent.  Amount. 

Central  Reserve  city,   ..     25  $375,000         4.18       $62,750 

Reserve  city,    15.6         234,375         3.34         50,150 

Country 7.4         111,093.75    2.50         37,550 

Here  is  a  reduction  for  central  reserve  cities 
of  from  25  per  cent  to  4.18  per  cent,  for  reserve 


extension  of  its  corporate  charter  may,  upon  the  affirma- 
tive vote  of  five  members  of  the  federal  reserve  board, 
have  its  legal  reserves  reduced  to  those  of  a  class  of 
cities  having  lower  requirements. 


17 

cities  from  15.6  per  cent  to  3.34  per  cent,  and 
for  country  bank  cities  from  7.4  per  cent  to 
2.50  per  cent;  giving  a  reduction  for  all  three 
banks  of  79  per  cent. 

State  banks  and  trust  companies  entering 
the  federal  reserve  system  have  generally 
experienced  substantial  reductions  in  legal  re- 
quirements so  far  as  actual  cash  reserves  are 
concerned. 

The  reduction  of  legal  reserve  requirements 
was  a  statutory  recognition  of  the  fact  that 
smaller  cash  reserves  are  needed  under  a  bank- 
ing system  possessing  a  group  of  central  banks 
of  issue  and  rediscount  than  are  needed  under 
a  highly  decentralized  system  of  banks  like  our 
American  banking  system  prior  to  the  federal 
reserve  act.  It  was  perfectly  proper  that  with 
the  establishment  of  the  federal  reserve  system 
the  legal  reserve  requirements  of  the  banks 
should  be  reduced.  Whether  the  reduction 
was  too  great  or  not,  only  experience  will  tell. 
In  the  writer's  judgment  the  reduction  was 
excessive,  and  it  was  a  mistake  to  discontinue 
all  cash-in-vault  legal  reserve  requirements  of 
member  banks.  The  important  fact,  however, 
to  note  here  is,  that  this  reduction  of  reserve 
requirements  taking  place  at  just  the  time 
when  the  country  was  being  flooded  with  gold 


18 

from  the  belligerent  countries  of  Europe^ 
created  the  possibility  of  a  tremendous  loan 
and  deposit  expansion. 

This  potential  expansion  was  quickly  turned 
into  an  actual  expansion  under  the  pressure  of 
four  important  forces.  They  were:  (1)  the 
natural  desire  of  bankers  and  business  men  for 
profit;  (2)  the  patriotic  impulses  of  bankers 
and  business  men  to  render  the  nation  the  best 
possible  services  in  its  time  of  emergency;  (3) 
the  desire  of  the  Government  to  finance  itself 
with  the  minimum  disturbance  to  legitimate 
business ;  ( 4 )  the  desire  of  the  Government  to 
float  its  war  securities  in  large  volume  at  the 
minimum  possible  rate  of  interest.  Let  us 
consider  these  forces  briefly. 

(1)  Take  the  case  of  a  bank  in  a  central 
reserve  city  which  had  been  normally  carrying 
a  cash  reserve  in  the  neighborhood  of  say  25 
per  cent,  because  that  was  the  minimum  per- 
centage required  by  law,  or  because  experience 
had  shown  that  a  reserve  of  about  that  size  was 
best  suited  to  its  particular  type  of  business, 


'  From  August  1,  1914,  to  April  1,  1917  (practically  the 
periocl  of  the  war  prior  to  our  entrance  as  a  belligerent), 
our  net  importations  of  gold  amounted  to  $1,109  millions 
and  this  enormous  increase  in  our  supply  we  maintained 
throughout  the  remainder  of  the  war.  We  have  most  of 
it  to  this  day,  although  there  have  been  substantial  losses 
since  the  armistice. 


1'3 

or  for  both  of  these  reasons.  Such  a  bank  we 
will  assume  after  the  establishment  of  the 
federal  reserve  system,  of  which  it  became  a 
member,  found  that  the  legal  reserve  require- 
ment against  demand  deposits  was  cut  to  13 
per  cent  and  that  the  greater  liquidity  of  its 
assets  brought  about,  through  the  facilities  for 
rediscount  and  collateral  loans  offered  by  the 
federal  reserve  system  would  apparently  make 
it  safe  for  it  to  reduce  its  reserve  to  17  per  cent 
(namely,  13  per  cent  legal  reserve  in  the  form 
of  a  deposit  with  its  federal  reserve  bank  and 
4  per  cent  cash  in  vault).  What  would  be 
such  a  bank's  probable  course  of  action  under 
these  circumstances?  The  answer  is  obvious. 
It  would  reduce  its  normal  reserve  percentage 
from  25  to  17^  because  by  so  doing  it  would 
increase  its  profits  without  materially  weaken- 
ing its  financial  position  or  impairing  its 
efficiency.  The  most  likely  method  of  doing 
this  and  the  method  that  would  probably  be 
used,  if  possible,  would  be  for  the  bank  to 
extend  its  loan  and  deposit  accounts.     To  do 


^  Of  this  17  per  cent,  13  would  be  in  the  form  of  a 
deposit  with  its  federal  reserve  bank  against  which  a 
cash  reserve  of  only  35  per  cent  would  be  legally  required, 
and  of  the  4  per  cent  till  money  held  by  the  bank  the 
greater  part  would  probably  consist  of  federal  reserve 
notes  against  which  the  federal  reserve  banks  would  be 
legally  required  to  hold  only  40  per  cent  cash  reserve. 


20 

this  it  might  well  reduce  its  discount  rates,  ex- 
tend the  credit  limits  of  its  best  customers,  and 
possibly  extend  credit  to  others  whom  it  had 
previously  refused  out  of  what  might  appear 
to  it  now  to  have  been  an  excess  of  caution. 
In  this  way  the  loan  account  would  be  ex- 
panded, deposits  would  be  increased,  and  the 
reserve  percentage  (legal  reserve  plus  till 
money)  would  be  reduced  from  25  per  cent  to 
the  new  norm  of  17  per  cent,  the  bank  thereby 
probably  realizing  for  its  stockholders  substan- 
tially increased  profits. 

If  this  reduced  reserve  requirement  were 
limited  to  one  bank,  the  possibility  of  deposit 
expansion  thereby  created  would  be  small  be- 
cause the  enlarged  deposits  resulting  from  the 
increased  loans  would  tend  to  give  the  bank  an 
unfavorable  clearing  house  balance,  and  to 
draw  quickly  away  thereby  a  part  of  its  reserve 
money.  Under  the  conditions,  however,  exist- 
ing during  the  war  period  this  opportunity 
and  this  motive  for  reserve  reduction,  or  in 
other  words  for  loan  and  deposit  expansion, 
were  open  to  all  of  the  national  banks  in  the 
country  and  to  large  numbers  of  state  banks 
and  trust  companies.  It  was  but  natural 
therefore  that  they  should  all  endeavor  to  ex- 
pand, in  order  to  take  advantage  of  the  oppor- 


21 

tunity  to  increase  their  profits.  The  hist  few 
years  have  been  highly  profitable  years  for 
commercial  banks. - 

Much  of  this  potential  loan  and  deposit 
expansion  appeared  in  the  early  years  of  the 
war,  when  the  demands  of  European  belliger- 
ents for  our  products  assumed  tremendous 
proportions  and  offered  high  profits  to  Ameri- 
can producers  of  war  materials,  so  high  as  to 
call  for  a  large  expansion  in  the  production  of 
these  materials.  Labor  was  shifted  from  "non- 
essential industries"  to  "essential  industries," 
and  while  many  of  the  former  lagged,  the 
latter  were  greatlj^  stimulated.  Here  then  was 
a  great  demand  for  increasing  bank  credit  at 
just  the  time  that  the  establishment  of  the 
federal  reserve  system,  the  reduced  cash  re- 
serve requirements  of  commercial  banks,  and 
the  heavy  imports  of  gold  from  Europe  were 
making  a  larger  loan  and  deposit  expansion 
possible.    The  new  federal  reserve  law  and  the 

Mn  each  of  the  fiscal  years  1017,  1918  and  1919,  the 
national  banks  of  the  country  showed  a  higher  percentage 
of  earnings  on  their  capital  stock  than  in  any  previous 
year  in  their  history.  The  average  earnings  on  capital 
stock  in  1917  were  17.96  per  cent,  in  1918  19.33  per  cent, 
and  in  1919  21.46  per  cent.  In  his  annual  report  for  1919 
(page  7)  tae  Comptroller  said:  "The  increase  in  the  net 
earnings  which  has  taken  place  in  the  past  five  years  thus 
amounts  to  $91,095,829,  which  exceeds  by  $4,491,778  the 
total  increase  in  net  earnings  shown  in  the  entire  40-year 
period  from  1874  to  1914." 


22 

heavy  gold  imports  created  a  potential  supply 
of  new  circulating  bank  credit,  the  war  stimu- 
lated the  demand.  It  was  to  the  banker's 
financial  interest  to  expand  credit,  and  to  the 
interest  of  many  groups  of  business  men  to 
seek  these  newly  available  funds. 

(2)  As  a  matter  of  patriotic  duty  bankers 
were  expected  to  expand  their  loans  and 
deposits.  Long  before  the  United  States 
enterd  the  war,  the  sympathy  for  the  Allies 
in  this  country  became  so  pronounced  and  the 
conviction  that  they  were  fighting  our  battles 
became  so  strong,  that  production  for  the 
Allies  and  the  granting  of  loans  to  finance  such 
production  were  felt  to  be  patriotic  acts. 
After  the  United  States  entered  the  war,  the 
extension  of  bank  credit  to  the  maximum  limit 
consistent  with  safety  to  "essential  industries," 
and  to  the  buyers  of  liberty  bonds  was  looked 
upon  as  the  paramount  duty  of  banks. 

(3)  The  demands  of  patriotism  were  looked 
upon  as  requiring  the  public  to  avail  them- 
selves to  the  limit  of  the  liberal  loan  facilities 
made  available  by  the  banks.  Nearly  every- 
where the  belief  prevailed  that  with  the  loans 
thus  available,  war  industries  should  expand 
their  production  and  the  public  should  buy 
bonds  to  the  maximum.     "Borrow  and  buy" 


23 

was  a  widely  used  slogan  in  the  first  three 
liberty  loan  campaigns,  and  was  strongly, 
although  more  quietly,  urged  upon  the  public, 
in  the  fourth  liberty  loan  and  the  victory  loan 
campaigns. 

(4)  In  their  laudable  desire  to  keep  interest 
rates  low  on  bank  loans  to  essential  war  indus- 
tries, and  more  importantly,  to  make  possible 
the  flotation  of  large  government  war  loans  at 
excessively  low  rates  of  interest,  the  federal 
reserve  authorities  adopted  a  policy  of  low  dis- 
count rates  for  the  federal  reserve  banks  and 
of  preferential  rates  and  great  liberality  for 
advances  made  on  the  security  of  government 
war  obligations.  Throughout  the  entire  period 
of  our  belligerency  the  loan  and  discount  rates 
of  the  federal  reserve  banks  were  below  the 
market  rates,  and  "the  market  was  in  the  fed- 
eral reserve  banks."  Funds  received  by  banks 
for  the  government  through  the  sale  of  liberty 
bonds  and  short-time  certificates  were  usually 
left  for  a  time  on  deposit  with  these  receiving 
banks  at  the  low  rate  of  of  2  per  cent  interest 
and  without  reserve  requirement.  This  policy 
greatly  expanded  deposit  credit.  When  the 
deposits  were  called  by  the  govermnent  the 
funds  for  meeting  the  calls  could  readily  be 
obtained  by  the   bank's   borrowing  from  its 


24 

federal  reserve  bank  either  by  the  rediscount 
of  war  paper,  or  by  a  direct  loan  collateraled 
by  government  security ;  and  the  rates  charged 
for  these  loans  were  usually  enough  lower  than 
the  rates  paid  to  the  banks  by  the  customer  for 
his  advance  used  in  buying  the  bonds  to  yield 
the  bank  at  least  a  small  net  profit.  The  result 
was  the  piling  up  of  many  billions  of  dollars 
of  liberty  bonds  and  certificates  of  indebted- 
ness in  the  commercial  banks  of  the  country 
and  the  federal  reserve  banks,  particularly  the 
latter,  in  the  form  of  collateral  for  loans. 
Federal  reserve  banks  loans  so  collateraled 
provided  member  banks  with  a  continuously 
increasing  supply  of  legal  reserves  for  further 
loan  and  deposit  expansion;  and  the  expan- 
sion of  federal  reserve  loans,  with  resulting  in- 
crease in  federal  reserve  deposits  and  issues  of 
federal  reserve  notes  was  continually  reduc- 
ing the  percentage  of  reserves  held  by  federal 
reserve  banks.  We  bought  our  low  interest 
rates  on  government  paper  at  the  price  of  very 
high  prices  for  commodities.  We  kept  interest 
rates  down  by  a  policy  that  kept  pusliing  the 
price  level  up. 

The  fundamental  economic  law  which  makes 
the  interest  rate  the  resultant  of  the  inter- 
action of  the  forces  of  demand  and  supply  in 


25 

the  capital  market  was  forcing  up  the  real  in- 
terest rate  under  the  influences  of  a  world  wide 
destruction  of  capital  and  an  unprecedented 
demand.  "Present  goods  were  at  a  large  and 
ever-increasing  premium  over  future  goods." 
The  fundamental  economic  law  determining 
the  real  interest  rate  could  not  be  annulled  by 
the  policy  of  the  federal  reserve  board  of  arti- 
ficially depressing  the  market  rate  of  discount 
through  inflating  the  country's  supply  of  bank 
notes  and  deposit  currency.  When  the  dis- 
count rate  was  artificially  j^ushed  down  prices 
bulged  up.  The  government,  it  is  true,  paid 
lower  rates  of  interest  on  its  bonds,  but  it  w-as 
compelled  to  pay  higher  prices  for  the  war  sup- 
plies it  bought,  and  was  therefore  compelled  to 
float  more  bonds.  It  paid  lower  interest  rates 
by  reason  of  this  policy,  but  it  paid  and  will 
pay  more  interest. 

Because  of  the  observation  that  the  more 
money  and  deposit  credit  an  individual  has 
the  more  goods  he  can  buy,  the  inference 
was  popularl}^  drawn  that  the  more  money  and 
deposit  credit  the  government  could  get,  the 
more  war  goods  and  services  it  could  buy. 

The  forces  above  described  favored  loan  and 
deposit  expansion.  Such  expansion  was  prof- 
itable to  the  banks  and  profitable  to  business 


26 

men,  while  to  the  banker,  the  business  man, 
and  the  ordinary  citizen,  the  acts  which  were 
resulting  in  this  expansion  appeared  to  be  acts 
of  patriotic  duty. 

The  heavy  drain  of  gold  which  such  a  con- 
dition of  affairs  would  normally  have  brought 
about  was  prevented  by  the  gold  embargo, 
which  w^as  in  effect  from  September  7,  1917, 
to  June  10,  1919,  by  the  government's  giving 
wide  publicity  to  the  doctrine  that  the  use  of 
gold  coin  or  gold  certificates  in  circulation  or 
the  holding  of  them  in  one's  possession  was  an 
unpatriotic  act,  that  all  gold  should  be  im- 
pounded in  the  federal  reserve  banks  where  it 
would  serve  the  country  with  maximum  effici- 
ency, and  by  the  further  fact  that  most  of  the 
leading  countries  of  the  world  were  inflating 
their  currency  and  bank  credit  at  even  more 
rapid  rates  than  we  were. 

The  result  was  an  expansion  of  bank  loans 
and,  in  consequence,  of  deposit  currency  such 
as  this  country  and  probably  no  other  country 
ever  saw  before  in  an  equal  space  of  time.  In 
the  following  table  the  expansion  of  bank  de- 
posits is  shown.  The  figures  cover  individual 
and  government  deposits  in  commerical  banks 
and  government  deposits  in  federal  reserve 
banks. 


27 


BANK   DEPOSITS   1913-1919. 

Deposits  in  State  Govt.  Deposits 
Deposits  in        Banks  and  Trust      in  Federal  Total 

National  Banks'-  Cos.^  Reserve  Banks^     Deposits 

Amount      Index       Amount      Index       Amount     Amount      Index 
(Millions J  Numbers  (Millions)  Numbers  (Millions)  (Millions  (Numbers 


1913,  . 

.  $G,020 

100 

$6,658 

100 

$12,678 

100 

1914,  . 

.   6,248 

104 

7,182 

108 

13,430 

106 

1915,  . 

.   6,912 

115 

7,499 

113 

14,411 

114 

1916,  . 

.  8,288 

138 

9,504 

143 

$48 

17,840 

141 

1917,  . 

.   9,923 

165 

11,194 

168 

156 

21,273 

168 

1918,  . 

.  11,540 

192 

12,099 

182 

132 

23,771 

188 

1919,  . 

.  13,113 

218 

14,708 

221 

107 

27,928 

220 

Here  we  have  within  a  period  of  six  years 
an  increase  in  our  national  bank  deposits  of 
approximately  118  per  cent,  or  over  seven 
billion  dollars,  and  an  increase  of  state  bank 
and  trust  company  dej^osits  of  over  121  per 
cent,  or  over  six  billion  dollars.  The  two 
together  represent  an  increase  of  over  120  per 
cent  of  our  deposits  in  commercial  banks  since 
1913,  or  an  increase  of  over  13  billion  dollars. 

Probably  80  to  85  per  cent  of  the  country's 
business  is  conducted  through  the  instru- 
mentality of  bank  checks.    It  is  through  checks 

'  Average  for  dates  of  five  or  six  comptroller's  calls  each 
year. 

*  Computed  from  figures  published  each  year  by  the 
Comptroller  cf  the  Currency  and  referring  to  a  date  about 
June  30. 

^  Figures  are  averages  for  the  government  deposits  on 
the  approximate  dates  of  the  comptroller's  calls  for  na- 
tional banks  each  year  so  as  to  correspond  as  nearly  as 
possible  with  the  figures  for  deposits  of  national  banks 
given  in  the  first  column. 


28 

that  deposits  circulate  and  that  the  bank's 
depositor  gives  expression  to  his  demand  for 
goods.  The  war  period  has  been  one  in  which 
deposits  have  circulated  at  a  more  rapid  rate 
than  usual  and  the  doubling  of  deposits  has 
therefore  probably  resulted  in  an  even  greater 
increase  in  the  country's  deposit  currency 
circulation. 

This  tremendous  increase  in  bank  deposits 
has  resulted  in  a  great  decline  in  the  average 
percentage  of  actual  cash  reserves  held  against 
deposits  — namely  the  ratio  of  deposits  (as 
above  computed)  to  actual  cash  held  by 
national  banks,  state  banks,  trust  companies, 
and  federal  reserve  banks  (exclusive  of  re- 
serves held  against  federal  reserve  notes). 
This  average  percentage  for  the  country  as  a 
whole  has  varied  as  follows  since  1913: 

PERCENTAGE  OF  CASH  RESERVE  TO  TOTAL 

DEPOSITS. 

Year  Percentage 

1913, 11-7 

1914, 11.7 

1915, 11-9 

191G 10.7 

1917,  10.6 

1918, 7.0 

1919 6.6 

The  proportion  of  gold  in  our  total  circula- 
tion has  likewise  materially  declined.    On  July 


29 


1,  lOlJ",  our  stock  of  monetary  gold  (namely, 
gold  coin,  plus  gold  bullion  in  the  treasury) 
was  equivalent  to  55.3  per  cent  of  our  total 
monetary  circulation  (as  computed  by  the 
Treasury  Department)  ;  and  on  June  1,  1920, 
it  was  equivalent  to  43.6  per  cent.  On 
June  30,  1914,  the  stock  of  monetary  gold  was 
equivalent  to  29.7  per  cent  of  our  national 
bank  deposits  (exclusive  of  bankers'  balances) , 
and  on  December  31,  1919  (the  date  of  the 
last  Comptroller's  call  for  which  figures  are 
available),  the  stock  of  monetary  gold,  less 
that  held  by  the  federal  reserve  system  as  re- 
serve against  issues  of  federal  reserve  notes, 
was  equivalent  to  only  14.1  per  cent  of  the 
national  bank  deposits. 

Briefly  summarizing  the  evidence  as  to  in- 
flation during  the  period  1913  to  1919,  we  find 
that  for  those  six  years  the  physical  volume  of 
business  increased  approximately  9.6  per  cent, 
the  monetar>^  circulation  71*  per  cent,  and  bank 
deposits  120  per  cent.  The  percentage  of 
actual  cash  reserve  held  against  deposits  mean- 
while declined  from  an  average  of  11.7  in  1913 
to  6.6  in  1919.  There  was  contemporaneously 
a  large  decline  in  the  ratio  of  gold  to  the 
country's  total  cash  and  to  its  total  supply  of 
exchange  media. 


30 

Is  it  surprising  under  the  circumstances  that 
the  level  of  prices  during  this  period  much 
more  than  doubled,  that  scarcely  any  com- 
modities of  importance  can  be  found  whose 
price  are  not  at  least  60  per  cent  higher  to-day 
than  in  1913,  and  that  the  public  is  up  in  arms 
against  the  high  and  rising  cost  of  living?  But 
this  is  the  subject  of  the  next  chapter. 


CHAPTER  II— HIGH  PRICES 


CHAPTER  II 

HIGH    PRICES 

The  great  increase,  noted  in  the  preceding 
chapter,  in  the  availahle  supply  of  currency 
and  circulating  credit  taking  place  at  a  time 
when  the  physical  volume  of  business  was  in- 
creasing but  slowly,  naturally  led  to  a  price 
bidding  contest  for  supplies  and  labor  between 
individuals  on  the  one  hand  and  individuals 
and  the  Government  on  the  other  under  the 
spur  of  war  needs — a  price  bidding  contest  that 
pushed  prices  up  to  heights  previously  un- 
dreamed of  in  this  country  since  the  greenback 
days  of  the  Civil  War. 

Of  course  even  without  inflation  the  prices 
of  those  commodities  for  which  the  war  made 
most  urgent  demands,  such  as  munitions,  ship 
building  materials,  and  the  like,  would  have  ad- 
vanced greatly,  but  these  advances  would  have 
been  compensated  for  by  declines  in  the  prices 
of  other  goods.  If  an  individual  with  a  given 
income  spends  more  for  articles  A,  B  and  C^ 
he  will,  of  necessity,  spend  less  for  articles  D, 
E  and/or  F,  unless  he  draws  on  his  capital,  in 
which  case  someone  else  will  have  less  to  spend 
on  these  or  other  articles.  A  shifting  of  the 
country's  economic  demand  from  one  kind  of 
goods,  say  the  goods  of  peace,  to  another  kind, 


say  the  goods  of  war,  will  force  up  the  prices 
of  the  latter,  and,  vice  versa,  force  down  those 
of  the  former.  If  more  of  the  circulating 
media  is  used  in  exchanging  the  war  goods  less 
will  be  available  for  exchanging  the  peace 
goods,  and  the  demand  for  them  will  fall  off 
with  a  consequent  reduction  in  their  prices. 
The  rise  in  the  prices  of  the  one  group,  how- 
ever, would  be  compensated  for  by  the  fall  in 
the  prices  of  the  other  and  little  or  no  change 
in  the  general  j)rice  level  would  result.  ^Mien, 
however,  this  shift  of  the  economic  demand 
from  peace  commodities  to  war  commodities  is 
accompanied  by  a  large  inflation  of  the  media 
of  exchange,  no  such  compensating  effect  is 
necessary.  There  may  be  an  ujDward  move- 
ment of  practically  all  prices  although  of 
course  the  prices  of  those  commodities  upon 
which  the  war  demand  is  concentrated  will 
advance  most. 

We  have  in  the  United  States  several  differ- 
ent series  of  price  index  numbers,  each  cover- 
ing a  different  number  and  combination  of 
commodities  and  each  being  computed  on  a 
different  base,  but  they  all  tell  essentially  the 
same  story.  That  story  for  the  period  1913 
to  1919,  as  regards  wholesale  prices,  may  be 
briefly  summarized  as  follows: 


35 

Last 
Number  Date 

of  Com-  YEAR.  Avail- 

NAME.  modities.  1913  1914  1915  1916  1917  1918  1910     able. 

Bureau   of   Lab.    Stat.,       328       100     100     101     124     176     196     212       2G5 

Apr.  1920 

Annalist 25i     100     104     106     126     187     20.5     211       235 

June  12, 
1920 

Bradstreet 96   100   97  107  128  170  203  203   216 

June  1920 

Dun 200   100  101  105  123  169  190  190   2l7 

June  1920 
War.  Indus.  Board,  ..  13G6   100   98  101  125  173  192  {")       201 

Dec.  1918 

All  these  general  index  numbers  show  an 
increase  in  average  prices  for  the  most  recent 
dates  in  1920  for  which  jfigures  are  available  of 
more  than  115%  over  those  of  1913,  while  all 
but  one  (Dun)  show  prices  throughout  1919  to 
have  averaged  more  than  double  what  they  did 
in  1913.  Taking  the  index  numbers  of  United 
States  Bureau  of  Labor  Statistics  as  the  most 
comprehensive  and  most  scientifically  pre- 
pared of  the  index  numbers  covering  the  entire 
period  1913  to  1919  inclusive,  we  may  say  that 
the  wholesale  price  level  increased  from  1913 
to  April,  1920,  165%;  in  other  words,  if 
one  calls  the  dollar  of  1913  a  100%  dollar  in  its 
purchasing  power  over  commodities  at  whole- 
sale, the  dollar  of  today  is  approximately  a 
38%  dollar. 

The  extent  of  this  depreciation  in  the  mone- 
tary unit  will  perhaps  better  be  realized  if  it  is 

1  Foods  only. 

2  Not   computed    for   1919. 


36 

compared  with  the  two  most  striking  cases  of 
monetary  depreciation  in  Anglo-Saxon  coun- 
tries of  the  last  century.  I  refer  to  the 
depreciation  of  the  Bank  of  England  notes 
during  the  period  of  the  Napoleonic  Wars, 
and  the  depreciation  of  our  American  green- 
backs during  the  period  1862  to  1878. 

Although  the  Bank  of  England  suspended 
specie  payment  February  27,  1797,  and  did 
not  resume  redeeming  its  notes  in  coin  until 
Maj^  1,  1821;  and  although  the  notes  were  at 
a  discount  in  terms  of  gold  and  silver  during 
the  greater  part  of  this  twenty-four-year 
period — a  discount  reaching  a  maximum  of 
about  41%^  for  the  year  1814 — the  greatest 
increase  in  wholesale  prices  for  the  period  of 
suspension  (using  1797  as  the  base  year)  was 
49%".  This  price  advance  is  equivalent  to  only 
about  two-fifths  of  the  price  advance  that  has 
taken  place  in  the  United  States  since  1913. 
Stated  in  another  way,  the  purchasing  power 
of  the  United  States  dollar  declined  about  62% 
from  1913  to  February,  1920,  while  that  of  the 


'  See  N.  F.  Silberling;  British.  Financial  Experience 
1790-1830.  The  Review  oi  Economic  Statistics,  October, 
1919,    pages    286-289. 

'  Jevons'  Index  Numbers  covering  wholesale  prices  of 
forty  commodities  converted  to  a  paper  basis.  Ibid.,  page 
283. 


S7 

irredeemable  bank  note  of  the  Bank  of  Eng- 
land declined  but  33%  during  the  entire  period 
of  the  Napoleonic  Wars. 

The  maximum  depreciation  of  the  American 
greenback  in  terms  of  gold  during  our  period  of 
suspended  specie  pajTiients  was  registered  on 
July  11, 1864,  when  gold  dollars  were  quoted  at 
a  price  of  $2.85,  giving  the  gi-eenback  dollar  a 
gold  value  of  only  35.09.^  We  hear  much  of 
the  greatly  inflated  paper  money  prices  of  the 
Civil  War  period,  and  yet  despite  this  decline 
of  the  gold  value  of  the  dollar  to  a  low 
point  only  slightly  more  than  one-third  of 
par,  the  maximum  increase  in  wholesale  prices 
during  the  period  of  suspension,  1861-1878, 
was  but  116%.^  This  is  a  smaller  advance 
than  that  represented  by  the  present  whole- 
sale prices  in  the  United  States,  as  com- 
pared with  1913,  the  average  increase  to  April, 
1920 — the  latest  date  for  which  Government 
figures  are  available — having  been  165  per 
cent.      In   purchasing  power  over  commodi- 


'  W.  C.  Mitchell,  Gold,  Prices  and  Wages  under  the 
Greenback  Standard,  page  295. 

•This  figure  is  based  upon  wholesale  prices  of  ninety- 
two  commodities,  and  represents  the  maximum  which  was 
reached  in  January,  1865.  See  A  Comparison  of  Prices 
during  the  Civil  War  and  Present  War.  Price  Section. 
Division  of  Planning  and  Statistics,  United  States  War 
Industries  Board,  1919,  pages  8-9. 


38 

ties  at  wholesale,  our  gold  currency  is  therefore 
more  depreciated  today  relative  to  1913  than 
was  the  inconvertible  greenback  of  the  Civil 
War  days  at  its  worst;  namely,  in  1865  as 
compared  with  1861. 

Our  war  and  after  war  rise  in  prices  has  not 
taken  place  in  the  form  of  a  great  rise  in  the 
prices  of  a  comparatively  few  important  com- 
modities needed  for  war  and  immediate  recon- 
struction purposes  accompanied  by  a  decline 
in  the  prices  of  other  kinds  of  commodities. 
On  the  other  hand,  price  increases  since  1913, 
like  those  of  the  greenback  period,  have 
covered  almost  every  class  of  commodities — 
war  commodities  and  peace  commodities,  "pro- 
duction goods"  and  "consumption  goods," 
absolute  necessities  and  rank  luxuries.  No  one 
can  make  a  study  of  price  movements  of  recent 
years  without  being  struck  by  the  wide  range 
of  commodities  affected  and  the  similarity  of 
the  price  curves,  shown  by  widely  different 
groups  of  commodities,  both  among  themselves 
and  with  the  "all  commodities"  group. ^  Of 
the  1437  commodities  whose  price  movements 


'  The  few  commodities  whose  prices  were  controlled  by 
the  government  during  the  latter  part  of  1917  and  during 
1918  rose  much  less  in  price  than  the  uncontrolled  com- 
modities. P.  W.  Garrett,  Government  Control  over  Prices. 
War  Trade  Board,  Washington,  1920,  pages  495-500. 


were  studied  by  the  War  Industries  Board, 
only  41,  or  less  than  .29  of  1%  were  lower  in 
1918  than  in  1913,  and  only  23,  or  .16  of  1% 
were  more  than  10%  lower.  Less  than  .22  of 
1%  of  the  total  were  400%  or  more  higher  in 
1918  than  in  1913,  and  of  these  31,  11  belong 
to  one  of  the  50  classes  of  commodities  studied 
— the  small  class  labeled  "coal  tar  crudes, 
intermediates,  and  dyes.""  Of  the  1437  differ- 
ent commodities  studied  by  Mitchell,  834  or 
58%  showed  price  increases  in  1918,  as  com- 
pared with  1913,  of  from  50  to  150%,  of  which 
431  showed  increases  of  from  50  to  90%. 
Forty-two  out  of  the  50  classes  of  commodities 
studied  embracing  1268  out  of  the  1437  com- 
modities, or  88%  of  the  total,  showed  average 
price  increases  of  over  75%  above  the  pre-war 
level.  ^ 

The  50  charts  sunmiarizing  these  war-time 
price  studies,  made  under  the  direction  of 
Professor  Mitchell  for  the  War  Industries 
Board  and  published  in  the  Summary  volume 
previously  cited,  are  most  illuminating.  The 
similarity  in  the  movements  of  these  curves  is 
striking,  and  forcibly  suggests  the  conclusion 


'  See  Wesley  C.  Mitchell,  History  of  Prices  During  the 
War,  Summary,  pages  5  and  20.  War  Industries  Board, 
Washington,  1919. 

^  Ibid.,   page  85. 


40 

that  the  dominant  torces  ai  work  in  causing 
the  rise  of  prices  in  most  classes,  namely,  all 
but  a  few  like  those  of  the  "heaw  chemicals," 
"essential  oils,"  and  "explosives"  groups,  have 
been  forces  acting  on  the  money  side  of  the 
price  ratio,  and  not  those  acting  on  the  com- 
modity side ;  in  other  words,  that,  in  the  main, 
general  prices  have  shown  their  phenomenal 
rise  of  recent  years  because  money  and  credit 
have  been  becoming  increasingly  plentiful 
rather  than  because  commodities  have  been 
becoming  increasingly  scarce. 

There  is  nothing  intrinsically  bad  in  high 
prices.  A  high  price  level,  when  once  com- 
pletely established,  that  is  when  prices  of  all 
kinds  of  commodities,  and  when  wages  and 
contracts  of  all  kinds  have  been  adjusted  to  the 
new  level,  assuming  an  adequate  metallic  base 
and  a  similar  level  of  prices  in  other  countries, 
such  a  high  price  level  is,  with  two  minor  quali- 
fications, to  be  noted  later,  no  better  and  no 
worse  than  a  low  price  level.  A  sudden 
doubling  of  prices  throughout  the  world,  if 
only  the  doubling  process  applied  uniformly 
and  at  once  to  the  prices  of  all  classes  of  goods, 
wholesale  and  retail,  to  all  kinds  of  wages,  all 
debts,  all  rates  and  fees,  all  annuities,  etc., 
would  not  be  materially  harmful  except  in  the 


41 

inconveniences  arising  from  the  necessity  of 
using  larger  figures  in  all  accounts  and  busi- 
ness operations,  and  in  the  inconvenience  of 
handling  a  bulkier  money. 

The  trouble  is  not  with  a  high  price  level  but 
with  a  rising  price  level  (and  for  that  matter, 
also,  with  a  falling  price  level),  and  with  the 
widely  different  rates  of  speed  at  which  the 
prices  of  different  kinds  of  goods  and  services 
become  adjusted  to  the  new  level.  It  is  in  the 
transition  to  the  new  price  level  that  the  diffi- 
culties arise. 

The  economic  and  social  results  of  a  great 
currency  and  bank  credit  inflation,  like  that 
we  have  been  experiencing  in  recent  years,  are 
large  and  far-reaching.  To  adequately  de- 
scribe them  would  require  volumes.  The  limits 
of  a  small  book  will  only  permit  a  brief  men- 
tion of  the  more  important.  These  may  be 
considered  under  two  broad  heads:  I.  Those 
results  that  are  concerned  with  the  contractual 
relations  between  debtors  and  creditors.  II. 
Those  results  that  are  concerned  with  the 
varying  degrees  of  responsiveness  of  the  prices 
of  different  kinds  of  goods  and  services  to  the 
inflationary  forces. 

I.  Contractual  relations  between  debtors 
and  creditors.    Money  is  good  for  what  it  will 


42 

buy — ^no  more  and  no  less.  If  we  assume  that 
broadly  speaking  the  purchasing  power  of  the 
dollar  has  been  cut  in  half  since  1913,  then  all 
existing  debts  that  were  outstanding  in  1913 
have  been  cut  in  half,  just  as  truly  as  if  they 
were  made  payable  in  a  fifty-cent  dollar,  at  the 
price  level  of  1913.  Measured  in  purchasing 
power  we  have  had  negative  interest  and  nega- 
tive interest  with  a  vengeance,  for  the  annual 
interest  payments  (which  likewise  have  grown 
smaller  in  purchasing  power  each  year)  have 
not  begun  to  compensate  for  the  depreciation 
of  the  principal.  The  creditor  has  actually 
been  paying  the  debtor  for  using  his  money, 
when  the  matter  is  viewed  from  the  standpoint 
of  purchasing  power.  Think  what  it  means  as 
regards  the  distribution  of  America's  wealth, 
to  cut  in  half  these  billions  and  tens  of  billions 
of  long  time  obligations!  This  applies,  with 
minor  qualifications,  to  all  bonds  and  deben- 
tures that  were  outstanding  in  1913  and  have 
not  yet  matured;  and  likewise  to  vast  quan- 
tities of  preferred  stocks;  it  applies  similarlj^ 
to  real  estate  mortgages,  to  savings  deposits 
accimiulated  in  1913  and  still  held,  to  the  paid- 
up  value  as  of  1913  of  biUions  of  dollars  of  life 
insurance;  and  to  our  present  day  military  and 
service  pensions  of  all  kinds  that  date  back  to 


43 

1913  or  earlier  and  whose  amounts  were  per- 
manently fixed  at  that  time.  This  fifty  per 
cent  debasement  of  the  value  of  these  billions 
of  dollars  in  bonds  and  other  funded  incomes 
or  income  rights  has  taken  place  equally, 
whether  the  owner  were  a  highly  prosperous 
individual  or  money-making  corporation,  an 
endowed  university,  library  or  charitable  in- 
stitution, or  a  widow  living  upon  a  pension  or 
upon  a  fixed  income  derived  from  insurance  or 
from  other  invested  funds. 

This  was  funda7iientally  not  a  destruction  of 
values  hut  a  transfer  of  them.  If  the  wealth 
of  the  United  States  to-day  were  valued  at 
1913  prices  it  would  probably  considerably 
exceed  the  values  of  1913.  Inflation  has  not 
directly  destroyed  property,  but  has  taken  it 
from  some  and  given  it  to  others.  In  general 
it  has  taken  it  from  the  creditor  and  given  it 
to  the  debtor.  Specifically  it  has  taken  from 
the  bondholder  and  given  to  the  stockholder. 
Practically  all  excess  profits  and  all  accretions 
to  the  value  of  plant  arising  from  inflated 
prices  have  gone  to  the  stockholder,  while 
the  bondholder  has  been  entitled  only  to  a 
fixed  amount  of  rapidly  depreciating  dol- 
lars. Inflation  has  taken  from  the  mort- 
gagee  and   given   to   the   mortgagor;   it   has 


44 

taken  from  the  recipient  of  military  pensions 
and  given  to  the  Government;  it  has  taken 
from  the  saving  banks  depositor  and  given  to 
the  savings  bank  borrower;  it  has  taken  from 
colleges  and  universities  and  given  to  the  stu- 
dents' parents  (through  a  cutting  in  half  of 
tuition  charges,  as  measured  in  purchasing 
power),  and  given  also  to  the  debtors  (stock- 
holders or  governmental  units)  who  are  obli- 
gors on  the  bonds  in  which  the  endowments  of 
these  educational  institutions  are  invested. 

Of  that  which  has  been  given  to  the  debtor, 
in  this  period  of  upheaval  in  the  relations  be- 
tween debtor  and  creditor,  it  should  be  added, 
much  has  been  taken  by  the  Government  in 
war  taxes.  That  which  has  been  taken  from 
the  holder  of  railroad  bonds,  and  the  bonds  of 
some  other  public  utilities,  the  rates  for  whose 
services  have  been  unduly  held  down  by  gov- 
ernment action,  while  expenses  have  been 
rising,  has  not  to  any  extent  been  given  to  the 
stockholder,  but  to  the  shipper,  the  merchant, 
and  the  ultimate  consumer  in  varying  degrees. 

^luch  that  has  been  given  to  the  public  has 
been  used  up  in  extravagant  living,  because 
many  of  the  recipients  have  not  been  a  capital 
saving  and  investing  class. 


45 

II.  Varying  Degrees  of  Responsiveness  of 
Prices  of  Different  Kinds  of  Goods,  The 
second  broad  group  of  economic  results  com- 
ing from  inflation  comprises  those  that  are 
concerned  with  the  varying  degrees  of  respon- 
siveness in  different  kinds  of  prices,  and  in  the 
prices  of  different  kinds  of  goods  in  each  class, 
to  the  stimulus  of  inflation/ 

It  has  long  been  recognized  by  economists 
that  as  a  general  proposition,  both  on  a  strong 
upward  movement  of  the  general  price  level 
and  on  a  strong  downward  movement,  whole- 
sale prices  as  a  class  normally  move  faster  than 
retail  prices,  and  retail  prices  as  a  class  nor- 
mally move  faster  than  wages.  This  conclu- 
sion is  well  supported  both  by  economic  theory 
and  economic  history.  A  striking  illustration 
of  the  principle  may  be  found  in  our  experience 
during  the  greenback  period,   from   1862   to 


^  Strictly  spec>Jdng,  the  subject  of  debts  and  funded  in- 
comes, previously  considered,  is  but  a  sub-division  of  this 
subject,  for  the  marlvet  values  of  these  debts  and  incomes 
are  but  one  form  of  price,  although  the  fact  that  they 
embody  rights  to  definite  amounts  of  the  same  kind  of 
depreciating  money  in  which  the  prices  are  quoted,  and 
that  their  market  prices  represent  to  a  considerable  extent 
a  capitalization  of  fixed  money  incomes  at  market  rates 
of  interest  that  the  inflationary  movement  itself  greatly 
influences — these  facts  make  long  time  debts  and  other 
funded  incomes  such  a  particular  class  of  "commodities" 
as  to  justify  their  separate  treatment. 


46 

1879.  The  careful  studies  of  Mitchell"  show- 
that  following  the  Civil  War  wholesale  prices 
in  terms  of  greenbacks  reached  their  maxi- 
mum in  1865,  retail  prices  in  1866,  and  wages 
in  1871.  The  evidence  concerning  price  and 
wage  movements  of  the  last  six  years  on  the 
w^hole  seems  to  support  such  a  conclusion, 
although  the  evidence  is  not  by  any  means  as 
yet  all  in,  and  although  that  available  is  some- 
wdiat  contradictory.  There  are  of  course 
numerous  individual  cases  where  retail  prices 
rose  earlier  and  to  greater  heights  than  whole- 
sale, and  likewise  numerous  cases  of  particular 
trades  or  industries  or  particular  localities  in 
which  wages  rose  earlier  and  farther  than  retail 
prices. 

AVholesale  prices,  we  have  seen,  have  in- 
creased on  an  average  165%  from  1913  to 
April,  1920.  Government  figures  show  that 
the  group  of  food  commodities  increased  for 
the  same  period  170% ;  that  the  commodity 
group  of  "cloths  and  clothing"  increased  253%, 
while  "metals  and  metal  products"  increased 
only  95  per  cent.  The  Government  figures  for 
the  retail  prices  of  12  important  articles  of 
food  show  an  average  increase  for  the  same 


^W.  C.  Mitchell,  Gold,  Prices  and  Wages  under  the  Green- 
back Standard,  chart  facing  page  280. 


47 

period  of  111%.  Retail  prices,  as  exemplified 
in  the  budgets  of  12,000  laboring  men's  fam- 
ilies in  92  localities,  covering  food,  clothing, 
fuel,  light,  and  house  furnishings,  show  an 
average  increase  from  1913  to  October,  1919, 
of  83.1%,'  and  to  December,  1919,  of  99%,  as 
compared  with  a  general  wholesale  price  in- 
crease to  December,  1919,  of  138%,  and  an 
increase  in  the  retail  prices  of  food  of  97%. 

Another  group  of  price  maladjustments 
resulting  in  large  part  from  inflation  is  that 
relating  to  railroads  and  other  public  utilities, 
the  prices  of  whose  services  and  products  are 
prevented  by  government  regulation  from 
moving  upward  with  the  general  price  level 
under  the  stimulus  of  inflation,  but  whose  costs 
for  materials,  equipment  and  wages,  continu- 
ally advance  under  that  stimulus. 

We  have  as  yet  no  very  comprehensive 
figures  for  wage  movements  throughout  the 
country  for  the  period  since  1913,  and  such 
figures  as  are  available  for  different  kinds  of 
labor,  and  even  for  the  same  kind  in  different 
localities,  show  widely  different  results.  Of 
course  it  is  well  known  that  wages  in  certain 
industries  for  whose  products  the  war  demand 
was  great,  and  likewise  all  classes  of  wages  in 

'  Monthly  Labor  Review,  Jan.,  1920,  pages  97-98. 


48 

centers  of  great  war  industrial  activity  rose 
rapidly  and  often  to  extravagant  heights ;  it  is 
likewise  well  known  that  the  wages  in  certain 
other  industries  rose  very  slightly.  Contrast 
the  case  of  the  powder  mill  worker  and  the 
puhlic  school  teacher,  the  mechanic  in  the  ship- 
building center  and  the  street  car  conductor  in 
the  interior  town  removed  from  any  great  war 
industry.  Regardless  of  what  figures,  yet  to 
be  prepared,  ma}^  show  as  to  what  happened 
to  that  much-talked-about  but  rather  indefinite 
thing  we  call  "average  wage"  since  1913, 
there  is  no  question  at  all  but  that  many 
laborers  received  wage  increases  far  in  excess 
of  the  rise  in  their  cost  of  living- — increases 
that  have  found  expression  in  all  sorts  of 
much-heralded  extravagances, — and  that  on 
the  other  hand,  the  wages  of  many  millions  of 
workers  have  not  begun  to  increase  as  rapidly 
as  their  cost  of  living — a  fact  that  has  found 
expression  in  great  and  widespread  hardship. 
Generally  speaking,  the  pay  of  government 
officials  and  clerks  has  not  begun  to  keep  pace 
with  the  rise  in  the  cost  of  living,  and  the  gov- 
ernment service,  civil  and  military,  is  badly 
suffering  as  a  result.  The  salary  situation 
among  teachers,  both  in  public  schools  and  col- 
leges,  has   become   notoriously   bad   and   our 


49 

whole  American  educational  program  is  being 
jeopardized.  Public  schools  are  closing  for 
lack  of  teachers,  and  colleges  are  losing  their 
faculties. 

The  industrial  survey  recently  conducted  by 
the  United  States  Bureau  of  Labor  Statistics 
covered  eight  industries.  For  these  eight  in- 
dustries respectively  the  average  percentage 
wage  increases  were  as  follows: 

Cigars,  52 ;  men's  clothing,  71 ;  furniture, 
54 ;  hosiery  and  underwear,  84 ;  iron  and  steel, 
121;  lumber,  94;  mill  work,  51;  silk  goods, 
91.  If  the  cost  of  living  increase  for  the  same 
period  is  taken  as  83.1  per  cent,  it  will  be  seen 
that  the  average  rate  of  wage  increase  in  three 
of  the  eight  industries  was  greater  than  the 
increase  in  the  cost  of  living;  in  four  of  them 
less,  and  in  one  of  them  practically  the  same.^ 

I  have  before  me,  given  on  the  same  page," 
two  tables,  one  containing  the  union  scale  of 
wages  by  rates  per  hour  for  boilermakers  in 
manufacturing  and  jobbing  shops,  for  the 
years  1913  to  1919,  in  twenty-five  widely  scat- 
tered American  cities;  and  the  other  contain- 
ing  similar   figures   for   bricklayers   in   forty 


^  Monthly  Labor  Review,  February,  1920,  page  116. 
'  Bureau    of    Labor    Statistics,    Monthly    Labor    Review, 
November,  1909,  page  173. 


60 

cities.^  In  a  few  cities  the  man  in  these  trades 
have  received  wage  increases  since  1913  appar- 
ently more  than  sufficient  to  compensate  for 
the  rise  in  the  cost  of  hving.  In  Baltimore, 
for  example,  the  rate  for  boilermakers  in- 
creased from  30.6  cents  per  hour  in  1913  to  80 
cents  in  1919,  an  increase  of  161%;  while  in 
Charlestown,  S.  C,  the  rate  for  bricklayers 
increased  from  40  cents  per  hour  in  1913  to 
75  cents  in  1919,  an  increase  of  88%.  On  the 
other  hand,  the  rate  for  boilermakers  in 
Chicago  which  was  40  cents  an  hour  in  1913, 
was  only  42  cents  in  1917,  52  cents  in  1918, 
and  60  cents  in  1919.  The  rate  for  bricklayers 
in  Jacksonville,  Florida,  was  62.5  cents  from 
1913  to  1918  and  then  rose  to  75  cents  in  1919. 
The  average  rate  for  boilermakers  in  the 
twenty-five  cities  was  39.5  cents  per  hour  in 
1913,  and  72  cents  per  hour  in  1919  (the  latest 
date  in  the  year  for  which  figures  are  available 
being  taken  for  the  year),  representing  an 
average  increase  of  82%,  or  just  about  enough 
to  meet  the  estimated  increase  in  the  cost  of 


'The  descriptive  matter  accompanying  the  tables  says: 
"The  union  wage  scale  figures  here  published  represent 
the  minimum  wage  of  union  members  *  *  *  but  these 
figures  do  not  always  represent  the  maximum  wage  that 
is  paid,  as  in  some  instances  part  or  even  all  of  the  organ- 
ized workers  in  the  trades  receive  more  than  the  scale  " 
This  was  true  both  in  1913  and  1919.     Ibid.,  page  172. 


51 

living.  The  average  rate  for  bricklayers  in  the 
forty  cities  in  1913  was  67.1  cents  per  hour, 
and  in  1919  it  was  90.2  cents  per  hour,  repre- 
senting an  average  increase  of  34.4  per  cent,  or 
probably  much  less  than  half  enough  to  com- 
pensate for  the  increase  in  the  cost  of  living. 

These  two  groups  of  figures  are  typical. 
Scores  of  similar  comparisons  might  be  made 
that  would  tell  essentially  the  same  story.  The 
wage  adjustment  to  the  new  price  level  has 
been  very  incomplete  and  very  uneven.  The 
adjustment  to  a  new  and  stable  equilibrium 
will  require  the  wages  of  some  kinds  of  labor  to 
be  relatively  decreased  and  those  of  others  to  be 
increased.  Many  adjustments  will  need  to  be 
made  in  the  relative  wage  scales  for  the  same 
kinds  of  labor  in  different  localities.  The 
adjustment  to  a  new  wage  equilibrium  in  har- 
mony with  the  new  price  level  will  require 
much  hardship,  much  bitter  feeling,  and  prob- 
ably much  labor  trouble.  Of  course  as  eco- 
nomic conditions  improve  wages  must  rise  rela- 
tively to  the  cost  of  living,  if  labor  is  fairly  to 
participate  in  the  country's  economic  progress. 

Probably  the  most  important  single  cause 
of  the  widespread  discontent  existing  through- 
out the  country  to-day,  and  one  of  the  prin- 
cipal causes  of  the  rapid  spread  of  economic 


52 

radicalism  is  the  rising  cost  of  living  with  its 
grossly  unequal  effects  upon  the  economic  wel- 
fare of  different  economic  classes  and  of  differ- 
ent groups  within  each  class.  In  connection 
with  the  discontent  that  usually  results  from 
inflationary  movements,  the  French  have  a 
saying  "the  guillotine  follows  the  paper  money 
press — the  two  machines  are  complementary 
one  to  the  other."  From  the  standpoint  of 
the  discontent  and  hardship  resulting,  it  would 
seem  to  make  little  difference  whether  the 
rising  cost  of  living  due  to  inflation  took  place 
through  the  depreciation  in  terms  of  gold  of 
paper  money  issued  to  excess  or  through  the 
excessive  uses  of  circulating  notes  and  deposit 
currency  which  are  kept  at  par  with  gold. 

Inflation  through  boosting  the  cost  of  living 
for  millions  of  people  at  rates  more  rapid  than 
it  boosted  wages  forced  these  people  to  rigid 
economies  that  released  labor  and  capital  for 
the  economic  conduct  of  the  war.  In  doing 
this  it  performed  a  useful  service ;  but  its  bur- 
dens were  grossly  unequal  and  ill-propor-; 
tioned  to  the  shoulders  that  were  called  upon 
to  bear  them.  The  war's  economic  burden  fell 
heavily  upon  those  wage-earning  and  small 
salaried  people  whose  incomes  lagged  far  be- 
hind prices  on  the  upward  move.    It  was  they 


53 

who  did  the  lion's  share  of  the  real  economizing 
that  released  the  labor  and  capital  needed  for 
the  production  of  the  sinews  of  war. 

Briefly  summarized  the  conclusions  of  this 
chapter  are  as  follows: 

Our  inflationary  policy  has  been  chiefly  re- 
sponsible for  the  great  rise  in  the  cost  of  living 
since  1913,  representing  a  reduction  of  some- 
thing over  50%  in  the  value  of  the  dollar.  A 
high  price  level  in  itself  is  neither  good  nor  bad, 
but  a  rapidly  rising  price  level  carries  in  its 
wake  many  economic  and  social  evils.  Inflation 
is  a  tremendous  engine  of  wealth  redistribution. 
It  acts  powerfully  but  blindly.  It  is  no  re- 
spector  of  persons  or  needs.  It  takes  from  the 
creditor,  whoever  he  may  be,  and  whatever  his 
economic  position  in  life,  and  gives  to  the 
debtor,  regardless  of  who  he  may  be,  or  what 
may  be  his  needs.  It  takes  from  one  class  of 
laborers  and  gives  to  another.  It  often  takes 
from  the  thrifty  and  gives  to  the  extravagant. 

Our  present  price  level  is  in  unstable  equilib- 
rium. Adjustments  are  uneven  and  incom- 
plete. Wages  in  particular  are  poorly  and 
unequally  adjusted  to  the  new  level  of  prices. 
The  problem  of  eliminating  these  maladjust- 
ments and  of  bringing  prices  and  wages  again 
into    equilibrium,    both    national    and    inter- 


64 


national,  will  be  a  difficult  one  and  will  demand 
for  its  solution  exceptional  intelligence,  cour- 
age, and  tolerance. 


CHAPTER  III— DEFLATION 


CHAPTER  III 

DEFLATION 

In  the  preceding  two  chapters  the  process  of 
inflation  was  explained,  the  degree  of  inflation 
existing  in  the  United  States  was  statistically 
examined,  and  some  of  the  more  important 
economic  consequences  of  the  resulting  high 
prices  were  considered.  These  were  questions 
of  fact  and  of  causation.  The  present  chapter 
is  chiefly  concerned  with  the  question  of 
policy.  Assuming  the  essential  soundness  of 
the  reasoning  in  the  preceding  two  chapters,  it 
asks:  What  should  we  do  about  it?  Should 
we  continue  to  inflate,  stay  where  we  are,  or 
deflate  i 

Whatever  may  be  said  in  favor  of  a  policy 
of  inflation  as  a  means  of  financing  a  great 
war,  little  can  be  said  in  favor  of  continuing 
such  a  policy  after  the  close  of  the  war.  The 
evils  of  inflation  are  very  real  and  we  know 
that  although  the  bubble  may  at  times  appear 
to  be  full  of  rainbows  it  must  burst  if  we 
continue  to  blow  it.  Let  us  pass  at  once,  there- 
fore, to  the  other  two  possibilities,  namely,  that 
of  maintaining  the  status  quo  and  that  of 
deflating. 

57 


58 

Why  not  accept  the  present  situation  as 
regards  currency  and  credit  inflation  with  its 
resulting  high  price  level  as  an  established  fact, 
and  frankly  adjust  our  economic  life  to  this 
new  level?  There  is  much  to  be  said  in  favor 
of  such  a  policy,  particularly  in  a  country  like 
the  United  States  that  has  maintained  itself 
during  the  inflation  period  on  a  gold  standard. 
The  chief  desideratum  in  a  sound  currency 
system  is  stability  in  the  value  of  the  monetary 
unit.  We  have  heard  much  since  1896  of  the 
evils  of  a  depreciating  monetary  unit  or,  in 
other  words,  of  the  rising  cost  of  living,  but 
these  were  not  our  monetary  troubles  of  a 
generation  ago.  Then  the  evils  were  those 
resulting  from  falling  prices— evils  that  led 
to  a  world-wide  agitation  for  bimetallism. 
Among  the  evils  of  falling  prices  so  strongly 
featured  in  the  monetary  discussions  of  the  last 
two  decades  of  the  19th  century  three  stood 
out  prominently,  they  were: 

(1)  The  injustice  of  a  falling  price  level  to 
the  debtor  classes. 

( 2 )  The  depressing  effect  of  a  falling  price 
level  upon  business. 

(3)  The  influence  of  a  falling  price  level  in 
reducing  the  demand  for  labor  and  thereby  in- 
creasing unemployment  and  depressing  wages. 


59 

The  general  wholesale  price  level  expressed 
in  terms  of  gold  fell  about  41  per  cent  in  the 
United  States  from  1872  to  1896.  In  other 
words,  if  one  calls  the  gold  dollar  of  1872  a 
100  per  cent  dollar  in  its  purchasing  power,  the 
dollar  of  1896  was  a  170  per  cent  dollar. 
Debtors,  therefore,  whether  they  were  farmers 
paying  money  on  farm  mortgages,  house- 
holders trying  to  pay  off  mortgages  on  their 
homes,  corporations  or  governmental  units 
with  bond  issues  of  some  years'  standing,  were 
being  called  upon  to  meet  their  obligations, 
principal  and  interest,  in  money  of  greater 
value  than  that  which  they  had  originally  bor- 
rowed. The  purchasing  power  of  a  gold  dollar 
was  increasing  on  an  average  about  214  P^r 
cent  a  year  (measured  geometrically).  The 
farmer's  mortgage  remained  unchanged  in  the 
amount  of  dollars  called  for,  principal  and  in- 
terest, but  the  rise  in  the  value  of  the  dollar 
caused  the  farmer  to  receive  continually  declin- 
ing prices  for  his  wheat,  cattle,  and  other 
products.  Appreciation  in  the  value  of  the 
dollar,  therefore,  or  a  falling  level  of  prices 
worked  much  injustice  to  the  debtor  classes  and 
this  injustice  was  the  most  important  item  in 
the  indictment  bimetallists  brought  against  the 
gold  standard. 


60 

The  same  principle,  although  with  mitigat- 
ing circumstances  to  be  noted  later,  would 
apply  to-day  should  we  pass  through  a  period 
of  deflation  and  falling  prices.  Many  people 
who  borrowed  "cheap  dollars,"  namely,  dollars 
of  low  purchasing  power,  during  the  period  of 
inflated  prices  would  suffer  hardship  in  being 
required  to  pay  their  indebtedness,  principal 
and  interest,  in  dollars  of  high  and  increasingly 
high  purchasing  power.  Debts  would  remain 
fixed  while  the  prices  of  the  articles  that  pro- 
ducers had  to  sell,  and  earned  incomes,  would 
decline  to  lower  levels. 

The  greatest  long-time  borrower  during  the 
period  of  the  war  was  the  Government.  Our 
net  war  debt  deducting  the  amount  due  us 
from  the  Allies  is  approximately  ten  and  one- 
half  billion  dollars.  Most  of  these  dollars, 
when  the  Government  received  them,  were 
dollars  of  low  purchasing  power.  If  we  should 
deflate  rapidly  and  substantially  the  Govern- 
ment would  repay  dollars  of  high  and  contin- 
ually higher  purchasing  power.  It  would  get 
these  higher  purchasing  power  dollars  by 
taxes.  In  the  light  of  modern  tendencies  in 
federal  taxation  it  appears  probable  that  those 
who  held  the  bonds  would  be  the  ones  who 
would  be  called  upon  ultimately  to  pay  the 


61 

lion's  share  of  the  taxes  which  would  provide 
the  Government  with  the  funds  for  interest 
payments  and  amortization.  But  the  public 
would  not  realize  this;  particularly  in  view  of 
the  tax  exemption  privileges  enjoyed  by  these 
bondholders.  It  does  not  require  much  imagi- 
nation therefore  or  political  acumen  to  see 
visions  of  attempts  at  deflation  being  countered 
in  the  near  future,  as  they  were  about  half  a 
century  ago,  by  the  charge  that  "the  great 
moneyed  interests,  the  tax  exempt  bond- 
holders, who  had  manipulated  the  market  so 
as  to  get  most  of  the  bonds  into  their  own 
hands,  had  artificially  depressed  commodity 
prices  and  were  exploiting  the  public  by  forc- 
ing up  the  value  of  the  dollars  the  Government 
owed  them."  These  words  will  have  a  familiar 
ring  to  persons  acquainted  with  the  demands 
of  the  Greenback  Party  of  1876  and  with  the 
charges  later  made  concerning  the  "Crime  of 
1873." 

Inflation  for  a  time  has  a  stimulating  effect 
upon  business.  Things  boom,  and  many 
classes  of  people  feel  prosperous  when  prices 
are  rising,  but  this  stimulant,  like  alcohol  when 
taken  in  excess,  always  has  its  "morning 
after."  A  falling  and  prospectively  falhng 
price  level  is  depressing  to  business.    It  throws 


62 

a  wet  blanket  over  industry.  When  the  pros- 
pects are  strong  for  a  period  of  declining 
prices  consumers  postpone  purchases,  retailers 
and  wholesalers  let  their  supplies  run  down, 
manufacturers  "play  safe"  both  in  running 
their  plants  and  in  purchasing  raw  materials. 
New  buildings  and  other  new  capital  equip- 
ment are  postponed  for  the  day  of  lower  prices. 
The  business  world  refuses  to  capitalize  in- 
flated prices.  The  expectancy  of  hea\'y  price 
reductions  breathes  a  spirit  of  uncertainty 
into  the  economic  atmosphere.  A  falling  price 
level  therefore  would  not  be  universally  popu- 
lar however  much  most  of  us  at  the  present 
time  think  we  would  like  to  see  it. 

The  third  evil  result  of  a  substantial  and 
continuing  decline  in  the  price  level  is  its  harm- 
ful effect  upon  the  welfare  of  labor.  This  is 
a  natural  result  of  the  depressing  effect  upon 
business  just  described.  When  business  holds 
back  in  anticipation  of  falling  prices  the  de- 
mand for  labor  declines  and  men  are  laid  off. 
Increasing  unemployment  causes  hardship  and 
is  a  potent  factor  in  forcing  down  wages  and 
weakening  the  hold  of  trade  unions  on  their 
men.  Labor  naturally  resists  wage  reductions 
even  though  the  price  level  is  falling,  and  this 


63 

means  that  a  period  of  falling  prices  is  likely  to 
be  characterized  by  many  labor  troubles. 

The  hardships  therefore  and  the  resulting 
political  difficulties  of  carrying  through  a  pro- 
gram of  price  level  reduction  through  deflation 
are  so  serious  that  we  should  enter  upon  such 
a  program,  if  at  all,  only  after  careful  delibera- 
tion and  under  the  pressure  of  strong  reasons. 
Are  there  strong  reasons  why  we  should 
deliberately  suffer  these  hardships  and  adopt 
a  program  of  deflation?  I  believe  there  are, 
provided  the  deflation  be  not  excessive,  and 
that  the  program  be  carried  through  with  firm- 
ness, moderation  and  reason. 

Why  then  is  deflation  necessary?  The 
strongest  reason  for  deflation  is  that  our  pres- 
ent gold  base  is  altogether  inadequate  safely 
to  support  the  present  paper  money  and  de- 
posit currency  circulation.  While  this  is  true 
of  the  United  States  it  is  true  to  a  much  higher 
degree  of  most  other  advanced  countires  of 
importance.  The  safety  and  security  of  our 
economic  organization  demand  that  there  be  a 
reasonable  relationship  between  the  size  of  the 
metallic  base  and  the  size  of  the  superstructure 
of  circulating  media  it  supports.  Long  ex- 
perience gave  each  country  a  rough  idea  of 
what  that  proportion  should  be  under  the  con- 


64 

ditions  existing  prior  to  the  great  war.  Of 
course  there  were  variations  in  this  proportion 
from  season  to  season  but  there  was  in  each 
country  a  fairly  recognized  norm  about  which 
these  seasonal  movements  fluctuated*  A  sug- 
gestion of  how  far  some  of  the  leading  coun- 
tries have  departed  from  that  ratio  of  metallic 
reserve  to  note  and  deposit  currency  circula- 
tion that  pre-war  experience  had  shown  to  be 
the  wise  one  will  be  found  in  the  figures  given 
in  the  following  paragraphs.  Unfortunately 
the  metallic  reserve  ratios  of  many  countries 
of  pre-war  days  and  those  of  to-day  as  officially 
published  are  not  strictly  comparable  because 
of  changes  wrought  by  the  war  in  currency  and 
banking  organization,  in  methods  of  comput- 
ing reserves,  and  in  the  character  of  the  pub- 
lished statistics.  The  figures  given  below 
therefore  should  be  considered  only  rough 
approximations.  Where  they  err,  they  are 
more  likely  to  err  on  the  side  of  understating 
the  decline  in  the  metallic  ratio  since  pre-war 
days  than  in  overstating  it,  for  in  belligerent 
countries  the  war  strain  encouraged  the  mak- 
ing of  as  good  a  showing  as  practicable. 

The  bank  notes  outstanding  from  the  issue 
department  of  the  Bank  of  England  on  May 
20,  1914,  were  £52.6  millions  against  which 


65 

the  issue  department  held  a  gold  coin  and 
bullion  reserve  of  ,£34.2  millions  or  65  per 
cent,  which  was  a  fairly  normal  percentage. 
On  March  3,  1920,  the  outstanding  bank  notes 
of  the  issue  department  were  £131.4  millions, 
and  there  was  outstanding  in  addition  ( March 
4)  government  currency  notes  to  the  amount 
of  £327.5  millions.  The  combined  outstand- 
ing note  circulation  was  therefore  £458.9 
millions.  Against  these  notes  there  was  a 
combined  gold  coin  and  bullion  reserve  on 
March  3  and  4,  1920,  of  £141.4  millions,  or 
31  per  cent.  On  May  20,  1914,  the  Bank  of 
England  was  carrying  a  reserve  of  43.6  per 
cent  against  its  dej^osits,  which  was  a  fairly 
normal  percentage,  and  on  March  3,  1920, 
this  reserve  had  fallen  to  19.6  per  cent. 

On  December  26,  1913,  the  Bank  of  France 
was  carrying  in  its  vaults  a  metallic  reserve  of 
62.10  per  cent  against  its  notes  and  deposit 
liabilities  combined,  which  was  about  a  normal 
reserve;  and  on  March  4,  1920,  this  reserve 
had  declined  to  9.3  per  cent.  The  metallic 
reserve  against  notes  and  deposits  of  the  Bank 
of  Italy  declined  from  71.2  per  cent  on  May 
20,  1914,  to  11.2  per  cent  on  October  31,  1919. 
That  of  the  National  Bank  of  Belgium  dcj- 
clined  from  31.7  per  cent  on  June  11,  1914,  to 


66 

5.1  per  cent  on  February  26,  1920.  The  Bank 
of  Japan  held  a  metalhc  reserve  of  43.2  per 
cent  on  June  30,  1914,  and  one  of  38.0  per  cent 
on  March  6,  1920. 

The  metalhc  reserve  of  the  German  Reichs- 
bank  was  42.72  per  cent  December  31,  1913, 
and  2.17  per  cent  February  23,  1920.  For  the 
Austro-Hungarian  Bank  the  metalhc  reserve 
declined  from  73.6  per  cent  on  June  25,  1914, 
to  0.53  per  cent  December  31, 1919.  In  Russia 
the  condition  is  much  worse,  where  the  situa- 
tion is  aggravated,  as  it  is  in  Germany,  by  huge 
issues  of  paper  money  in  addition  to  ordinary 
bank  notes. 

The  neutral  countries  of  Europe  are  gener- 
ally supposed  to  have  had  their  banking 
positions  strengthened  by  the  war.  These 
countries  are  mostly  countries  of  compara- 
tively small  populations  (Spain  being  the 
largest  with  less  than  21,000,000),  and  of 
secondary  importance  as  factors  in  the  world's 
market  for  gold. 

For  the  Bank  of  Spain  the  ratio  of  the 
metallic  reserve  to  circulation  and  deposits  in- 
creased from  46.76  per  cent  on  December  27, 
1913,  to  62.4  per  cent  on  February  28,  1920. 
For  the  Netherlands  Bank  there  was  an  in- 
crease from  52.4  per  cent  on  March  31,  1914, 


67 

to  55.79  per  cent  on  February  28,  1920.  For 
the  National  Bank  of  Switzerland  there  was  a 
decline  from  62.9  per  cent  on  June  11,  1914, 
to  60.5  per  cent  on  February  23,  1920.  The 
Bank  of  Norway  showed  a  decline  from  39.7 
per  cent  on  June  15,  1914,  to  31.0  per  cent  on 
February  23,  1920;  and  the  Bank  of  Sweden 
a  decline  from  36.8  per  cent  on  June  13,  1914, 
to  31.9  per  cent  on  February  21,  1920.  Every 
one  of  these  neutral  countries  has  experienced 
a  great  increase  in  the  volume  of  metallic  re- 
serve in  its  national  bank,  but  three  out  of  the 
five  national  banks  have  expanded  their  bank 
notes  and  deposits  more  than  proportionately 
with  a  consequent  reduction  in  the  percentage 
of  reserve;  and  one  of  the  other  two  has  not 
improved  its  reserve  position  very  much. 

Taken  as  a  whole  the  above  figures  point  to 
the  conclusion  that  unless  Europe's  metallic 
reserve  percentages  were  vastly  in  excess  of 
her  needs  during  pre-war  times — and  there  is 
no  evidence  that  they  were — they  are  to-day 
altogether  inadequate  to  support  on  a  par  gold 
basis  Europe's  present  volume  of  notes  and 
circulating  deposit  credit. 

I^et  us  now  turn  to  the  United  States,  the 
country  that  is  supposed  to  have  absorbed  the 
larger  part  of  the  gold  lost  by  the  belligerent 


68 


countries  of  Europe.  Unfortunately  a  change 
made  some  time  ago  in  the  form  of  compihng 
the  bank  figures  published  by  the  Comptroller 
of  the  currency  makes  it  no  longer  possible  to 
tell  how  much  gold  is  held  by  reporting  banks 
in  their  own  vaults.  This  fact  together  with 
the  complete  reorganization  of  our  legal  re- 
serve requirements,  brought  about  by  the 
establishment  and  development  of  the  federal 
reserve  system,  renders  a  comparison  of  the 
exact  percentages  of  gold  reserve  held  in  the 
United  States  before  the  war  and  now,  imprac- 
ticable. Some  idea  of  our  changed  position 
since  June,  1914,  however,  may  be  found  by 
comparing  for  that  date  and  the  present  the 
ratios  of  our  stock  of  monetary  gold  to  the 
total  amount  of  money  in  circulation  and  to 
total  individual  deposits  in  national  banks. 
These  figures  have  been  previously  given,  ^  and 
need  only  be  summarized  here. 

Our  stock  of  monetary  gold  on  July  1,  1914, 
was  equivalent  to  55.3  per  cent  of  our  total 
monetary  circulation,  and  on  June  1,  1920,  it 
was  equivalent  to  43.6  per  cent.  On  the 
former  date  it  was  equivalent  to  29.7  per  cent 
of  our  national  bank  deposits    (exclusive  of 


'  Pages  28  and  29.  See,  also,  the  author's  article  on  Infla- 
tion in  American  Economic  Review,  June,  1918,  pages 
251-252. 


69 


bankers'  balances) ,  and  on  December  31,  1919, 
the  stock  of  monetary  gold,  less  that  held  by 
the  federal  reserve  system  as  reserve  against 
federal  reserve  notes,  was  equivalent  to  only 
14.1  per  cent  of  the  national  bank  deposits. 
Ultimate  cash  reserves,  against  deposits  in 
commercial  banks,  declined  from  an  average  of 
11.7  per  cent  in  1914  to  6.6  per  cent  in  1919. 

Our  gold  position  is  thus  far  below  that  of 
pre-war  times  and  we  have  been  losing  gold  on 
net  balance  almost  continually  since  May, 
1919,  our  net  loss  for  the  period  January  1, 
1919,  to  June  10,  1920,  having  been  in 
round  numbers  $386  millions.  To  us,  however, 
more  than  to  any  other  country,  belligerent 
Europe  ultimately  will  look  for  the  replenish- 
ment of  her  gold  in  order  to  return  to  a  specie 
basis. 

A  second  reason  in  favor  of  deflation, 
although  one  that  grows  weaker  the  longer  de- 
flation is  postponed,  is  found  in  the  fact  that 
inflation's  work  has  not  yet  been  completed 
and  that  therefore  some  of  the  otherwise  evil 
results  of  our  inflation  experience  would  still 
be  avoided  or  mitigated  by  deflation.  There 
are  still  outstanding  in  this  country  many 
billions  of  dollars  of  long-time  obligations 
which  date  from  the  pre-war  period,  have  still 


70 

some  years  to  run  before  maturity  and  which 
continue  in  the  hands  of  their  pre-war  owners. 
Probably  most  of  the  bonds  and  mortgages 
owned  by  savings  banks/  insurance  companies, 
educational,  charitable,  and  other  endowed  in- 
stitutions belong  to  this  class,  as  do  also  many 
of  the  non-war  bonds  to-day  held  in  the  strong 
boxes  of  individual  investors.  If  these  bonds 
were  sold  to-day  or  were  to  mature  with  com- 
modity prices  at  their  present  high  level  they 
would  be  paid  for  or  paid  off  in  greatly  depre- 
ciated dollars;  but  if  we  should  have  a  period 
of  substantial  deflation  with  falling  prices  the 
owners  of  these  bonds,  the  depositors  in  the 
savings  banks,  the  beneficiaries  of  the  insur- 
ance policies,  etc.,  would  benefit,  and  to  the 
extent  that  they  were  the  same  persons  who 
held  the  bonds,  owned  the  deposits,  etc.,  in  the 
pre-war  times,  they  would  get  back,  in  part 
at  least,  what  they  now  appear  to  have  lost 
through  inflation. 


'  The  writer  estimated  in  1918  on  the  basis  of  figures 
collected  through  a  questionnaire  of  the  American  Bankers 
Association  that  the  622  mutual  savings  banks  of  the 
country  held  bonds  and  other  securities,  with  maturities 
later  than  ten  years,  of  $1,680  millions.  It  is  doubtful 
whether  these  securities  have  to  any  extent  been  since 
disposed  of.  Bankers  Convention  Section,  Commercial  and 
Financial  Chronicle,   October  12,  1918,  p.  207. 


71 

Although  the  situation  seems  to  make  defla- 
tion necessary,  it  does  not  by  any  means  follow 
that  an  effort  should  be  made  to  deflate  to  the 
pre-war  price  level.  From  1896  to  1913  our 
American  wholesale  price  level  rose  about  50 
per  cent,  representing  an  average  annual  in- 
crease {measured  arithmetically)  of  approx- 
imately 3  per  cent.  Even  without  the  war, 
therefore,  we  might  reasonably  have  expected, 
as  the  result  of  a  continuation  of  pre-war 
forces,  an  increase  in  prices  from  1913  to  1920 
of  something  like  20  per  cent. 

But  much  more  important  than  this  is  the 
fact  that  the  war  period  has  probably  wrought 
important  permanent  changes  in  our  cur- 
rency and  banking  systems — changes  which 
will  greatly  improve  the  efficiency  of  these 
systems  and  thereby  enable  a  given  amount  of 
gold  to  carry  on  its  shoulders  a  larger  load 
of  exchange  work  than  in  pre-war  days.  This 
is  a  large  subject  and  only  a  few  phases  of  it 
can  be  suggested  here. 

It  appears  likely  that  in  the  future  the 
world's  supply  of  monetary  gold  will  be  found 
to  an  increasing  extent  in  the  vaults  of  central 
banks  and  will  be  used  to  a  decreasing  extent 
for  purposes  of  hand  to  hand  circulation.  This 
will  greatly  increase  the  monetary  efficiency 


72 

of  the  average  ounce  of  monetary  gold.  Fur- 
thermore the  establishment  and  development 
of  our  federal  reserve  system,  the  increasing 
movement  for  bank  consolidation  in  Europe 
and  America,  the  reduction  of  gold  shipments 
both  national  and  international  through  the 
creation  of  such  devices  as  our  gold  settlement 
fund,  and  the  increasing  use  of  funds  located 
abroad  for  making  international  payments 
through  debits  and  credits  without  the  neces- 
sity of  shipping  gold — these  changes  and  others 
of  a  similar  character  are  resulting  to  an  ever 
increasing  degree  in  economizing  the  use  of 
gold  and  in  thereby  reducing  the  ratio  of  the 
gold  base  to  the  credit  superstructure  it  sup- 
ports. We  can  do  a  given  amount  of  money 
work  with  less  gold  because  gold  is  being  made 
to  work  harder  and  more  efficiently. 

A  factor  which  may  possibly  reduce  the 
structure  of  circulating  credit  in  proportion 
to  the  gold  base  is  the  debasement  of  the  gold 
units  of  value  in  certain  foreign  countries. 
When  one  notes  the  tremendous  depreciation 
to-day  in  the  gold  values  of  the  paper  money 
units  of  many  belligerent  countries,  at  a  time 
when  the  value  of  gold  itself  in  terms  of  com- 
modities has  been  more  than  cut  in  half  in  six 
years,  and  when  he  notes  the  staggering  bur- 


73 

dens  of  debt  these  countries  are  carrying  he 
need  not  be  surprised  to  hear  increasing  de- 
mands among  their  peoples  for  debasing  the 
legal  gold  unit  of  value.  Advocates  of  debase- 
ment will  point  out  that  the  government  in 
floating  its  domestic  debt  received  its  pay 
largely  in  greatly  depreciated  paper  money. 
They  will  show  that  even  if  it  were  possible 
for  the  government  ultimately  to  pay  these 
domestic  debts  in  the  old  monetary  units,  at 
a  parity  with  gold,  such  payment  would  in- 
volve an  oppressive  burden  of  taxation  that 
would  be  grossly  unjust  in  that  it  would  give 
to  the  bondholder  a  much  more  valuable  money 
than  he  originally  loaned  to  the  Government. 
They  will  stress  the  depressing  influences  on 
all  kinds  of  business  of  a  currency  contraction 
that  would  bring  the  value  of  the  present  paper 
monetary  unit  back  to  par,  a  contraction  in 
some  countries  as,  for  example,  in  Germany, 
Austria  and  Russia,  of  thousands  per  cent.  It 
appears  probable  that  we  shall  witness  in  the 
near  future  widespread  and  vigorous  move- 
ments in  many  countries  in  favor  of  the  adop- 
tion of  new  gold  units  of  value  somewhere  in 
the  neighborhood  of  their  de  facto  paper 
money  unit  of  to-day,  or  at  least  much  lower 
than  their  pre-war  gold  units.    Monetary  his- 


tory  is  full  of  examples  of  such  debasement. 
If    the    existing    paper    money    unit    should 
appear  to  be  of  an  inconveniently  small  value, 
its  name  might  be  continued  and  also  its  legal 
pov*^er  in  settlement  of  domestic  debt,  while  a 
new  unit  might  be  superimposed  upon  it  of 
which  the  old  unit  would  become  merely  a 
division.      Suppose,    for   example,   the   mark 
should  be  stabilized  at  a  gold  value  of  2.5  cents 
United  States  currency,  retaining  its  name  and 
its  present  domestic  debt-paying  powers,  and 
suppose  this  mark  should  be  made  the  "dime" 
of  a  new  German  unit  worth,  say  25  cents, 
United  States  currency,  and  called  perhaps  a 
"Hindenburg."     Obviously  by  such  a  process 
a  given  weight  of  gold  in  Germany  would  have 
its  efficiency  for  reserve  purposes  multiplied 
approximately  ten  times,  and  the  return  to  a 
gold  basis  would  be  greatly  expedited.     That 
this  would  be  a  form  of  domestic  debt  repudia- 
tion and  be  open  to  many  serious  objections 
is  of  course  obvious.     Here  we   are  neither 
arguing  for  or  against  such  a  proposition,  but 
merely  pointing  out  that  to  a  large  number  of 
people  in  the  most  debt-burdened  and  paper 
money-ridden    countries    of    Europe    such    a 
course  is  likely  to  appear,  with  all  its  difficul- 
ties, to  be  the  least  objectionable  road  to  day- 


76 

light.  The  adoption  of  such  a  program  by 
some  countries  would  obviously  reduce  the 
amount  of  deflation  necessary  in  other  coun- 
tries to  bring  the  structure  of  circulating  credit 
down  to  a  reasonably  safe  multiple  of  the  gold 
base. 

How  should  deflation  be  brought  about? 
This  is  a  large  question  in  itself  and  the  limits 
of  this  book  will  prevent  anything  more  than 
the  mention  of  a  few  points.  In  general,  it 
may  be  said,  we  must  reverse  the  process  by 
which  we  inflated.  By  maintaining  official 
discount  and  loan  rates  at  federal  reserve 
banks  below  the  market  rates  and  by  granting 
rediscounts  liberally,  we  placed  "the  market 
in  the  federal  reserve  banks,"  we  encouraged 
a  "borrow  and  buy"  policy  for  war  bonds  and 
certificates  of  indebtedness,  and  made  borrow- 
ing that  resulted  in  a  rapid  expansion  of  our 
circulating  bank  credit — deposit-credit  and 
federal  reserve  notes — appear  to  be  both 
profitable  and  a  matter  of  patriotic  duty  to  all 
parties  concerned. 

The  fact  that  these  two  kinds  of  circulating 
credit  were  interchangeable  to  the  public 
on  demand,  by  the  deposit  of  federal  reserve 
notes  or  by  the  cashing  of  checks  for  notes, 


76 

enabled  the  public  to  decide  what  proportion 
of  this  increased  supply  of  circulating  credit 
it  should  hold  in  the  form  of  deposits  and  what 
proportion  in  the  form  of  federal  reserve 
notes.  We  inflated  by  expanding  circulating 
credit.  The  public  decided  the  form  in  which 
this  newly  created  credit  should  circulate. 

Preferentially  low  discount  rates  on  war 
paper  were  an  additional  factor  in  this  deposit 
and  note  expansion,  and  one  that  explains  in 
part  the  large  holdings  of  such  paper  by  our 
banking  instituions,  holdings  that  are  esti- 
mated to  amount  to  something  in  the  neigh- 
borhood of  six  billion  dollars. 

Now  that  the  war  is  over  this  sort  of  expan- 
sion clearly  should  be  stopped.  War  patriot- 
ism and  progressive  bank-credit  expansion  can 
no  longer  buoy  up  the  prices  of  billions  of  dol- 
lars of  war  securities  to  artificially  high  levels. 
The  real  market  rate  of  interest  must  now 
emerge  and  dominate  the  situation.  There  is 
no  question  but  that  the  real  rate  is  much 
higher  than  the  camouflaged  war  rate.  To  an 
increasing  degree  Government  war  bonds  and 
certificates  of  indebtedness  must  stand  upon 
their  own  bottoms  as  investments. 

The  market  should  be  "outside  of  the  fed- 
eral   reserve    banks."      In    other    words,    the 


11 

federal  reserve  bank  rate  should  rule  as  it 
did  before  our  entrance  into  the  war,  and  as 
does  usually  the  Bank  of  England's  official 
discount  rate,  higher  than  the  market  rate  so 
that  recourse  by  banks  to  the  discount  and  loan 
facilities  of  the  federal  reserve  banks  should 
be  only  an  emergency  recourse  for  temporary 
needs,  not  a  recourse  for  permanent  funds. 

In  the  future  preference  should  be  shown  to 
short-time  loans  of  a  self-liquidating  character, 
as  originally  contemplated  by  the  federal  re- 
serve system;  and  to  an  increasing  degree, 
loans  on  the  security  of  government  debt 
should  be  discriminated  against  by  federal 
reserve  banks,  both  as  to  discount  rates  and 
in  the  matter  of  the  banks'  discretion,  as  to 
how  much  they  shall  loan  and  to  whom.  Grad- 
ually but  firmly  government  paper  should  be 
forced  out  of  the  federal  reserve  banks  and 
out  of  the  commercial  member  banks  and  into 
the  strong  boxes  of  the  investing  public,  in^ 
eluding  the  vaults  of  savings  banks,  insurance 
companies,  and  endowed  institutions.  To  this 
end,  in  my  judgment,  the  federal  reserve 
banks  should  follow  up  their  recent  advances 
in  discount  rates,  gradually  raising  the  rates 
higher  until  they  become  effective  in  forc- 
ing contraction.     The  present  preferentially 


78 

low  rate  on  loans  secured  by  certificates  of 
indebtedness  should  be  discontinued.  If  an 
artificially  and  preferentially  low  rediscount 
rate  is  necessary  in  order  to  enable  the  govern- 
ment to  float  these  securities  at  their  present 
low  interest  rate,  then  we  are  paying  the  price 
of  further  inflation  for  a  low  interest  rate  on 
the  certificates.  In  that  case  why  not  frankly 
recognize  the  fact  that  in  an  unsupported 
market  the  present  rate  is  too  low  and  should  be 
raised,  if  further  issues  become  necessary. 

The  same  principle  applies  to  government 
bonds.  If  the  market  rate  for  these  bonds, 
unsupported  by  an  inflationary  loan  policy  on 
the  part  of  the  federal  reserve  banks,  proves 
to  be  much  higher  than  the  par  rates  they  pay 
(when  due  allowance  is  made  for  the  tax 
exempt  privileges  of  these  securities  and  for 
the  government's  program  of  gradual  debt 
reduction),  and  if  resulting  heavy  declines  in 
bond  prices  work  hardship  to  innocent  bond- 
holders who  bought  their  bonds  in  good  faith, 
then  the  government  might  well  consider  plans 
of  refunding  at  a  fair  market  rate  of  interest. 
We  should  not  be  under  the  necessity  of  seri- 
ously impairing  our  banking  system  and  of 
perpetuating  highly  inflated  and  unstable  cir- 
culating media,  with  consequent  high  prices. 


79 

in  order  to  buoy  up  the  market  prices  of  bonds 
that  were  floated  at  abnormally  low  interest 
rates  on  waves  of  war  patriotism. 

The  federal  reserve  banks  might  well  be 
decreasingly  receptive  to  applications  for  loans 
and  rediscounts  from  banks  which  they  know 
are  lending  their  own  funds  heavily  in  the 
speculative  market,  or  are  extending  credit 
unduly  for  the  production  and  marketing  of 
luxuries,  and  from  banks  whose  borrowings 
from  their  federal  reserve  banks  are  dispro- 
portionately large  as  compared  with  their 
capitals.^  Although  the  law  already  gave  the 
federal  reserve  authorities  large  discretion- 
ary powers  in  such  matters,  it  is  well  that 
the  government  has  just  strengthened  their 
hands  by  passing  the  "Phelan  Act"  which 
authorizes  them  to  charge  progressively  higher 
rates  of  discount  on  paper  rediscounted  for  any 
banks  in  excess  of  what  may  be  considered  a 
normal  line. 

Federal  reserve  banks  whose  gold  reserves 
against   federal   reserve   notes   fall   below   40 


'  By  using  capital  or  capital  and  surplus  as  the  criterion 
Instead  of  deposits,  much  needed  pressure  would  be 
exerted  to  force  many  of  our  banlcs  to  increase  their  cap- 
ital funds  to  a  safer  percentage  of  their  deposit  liabilities. 
See  the  author's  article  on  The  Ratio  of  Bank  Capital  to 
Deposits.  Bankers  Statistics  Corporation  Service  of  May 
4,  1920. 


80 

per  cent,  after  allowing  for  a  35  per  cent  law- 
ful money  reserve  against  deposits,  should  be 
promptly  subjected  to  the  tax  on  deficiency 
reserves  provided  for  in  Section  11,  Paragraph 
(c)  of  the  Federal  Reserve  Act. 

The  federal  reserve  banks  are  the  strongest 
central  banking  system  in  the  world  to-day. 
For  some  time  their  reserve  position  has  been 
growing  progressively  weaker.  Much  of  the 
"slack  has  been  taken  up."  These  banks  will 
be  the  world's  greatest  financial  conservator  in 
the  trying  times  of  reconstruction  confronting 
us.  They  must  keep  strong  and  highly  liquid 
so  as  to  be  prepared  to  meet  their  responsi- 
bilities to  America  and  to  the  world. 

If  deflation  is  to  be  accomplished,  obviously 
governments  must  stop  meeting  current  ex- 
penses by  printing  paper  money  and  by  issu- 
ing bonds  to  be  hypothecated  in  large  quan- 
tities at  banks.  Governments  must  practice 
most  rigid  economy,  keep  their  current  ex- 
penses well  within  their  current  incomes,  and 
proceed  promptly  as  the  United  States  is 
doing,  to  a  gradual  reduction  of  the  war  debt. 

We  should  not  permit  our  commercial  banks 
to  be  loaded  up  with  European  public  debt  or 
other   long-time   foreign   obligations.     How- 


SI 

ever  good  and  desirable  such  investments  may- 
be, their  place  is  not  in  our  commercial  banks. 

The  principal  conclusions  of  this  chapter 
may  be  summarized  as  follows : 

Deflation  is  a  painful  economic  process.  By 
raising  the  value  of  the  monetary  unit  in  which 
debts  are  expressed  it  places  unjust  burdens 
upon  many  debtors  to  the  advantage  of 
creditors.  It  depresses  business,  and  tends  to 
reduce  the  demand  for  labor  thereby  increas- 
ing unemployment,  forcing  down  wages,  and 
causing  labor  troubles. 

Despite  these  evils,  world  deflation  is  abso- 
lutely necessary,  although  less  deflation  is 
needed  in  the  United  States  than  in  most  ad- 
vanced countries.  The  existing  gold  base  is 
altogether  inadequate  safely  to  support  the 
present  paper  money  and  deposit  currency 
circulation  at  a  parity  with  existing  gold 
monetary  units  in  a  free  gold  market.  Fur- 
thermore, inflation's  work  has  not  yet  been 
completed  and  therefore  some  of  the  otherwise 
evil  results  of  our  inflation  experience  could 
still  be  avoided  or  mitigated  by  deflation. 

There  is  no  need  of  deflating  to  the  pre-war 
price  level.  Even  without  the  war  the  price 
level  would  presumably  be  considerably  higher 
to-day  than   in   1913.      The   war   period   has 


82 

taught  many  lessons  and  brought  about  many 
improvements  in  currency  and  banking  that 
will  render  a  given  amount  of  monetary  gold 
more  efficient  than  before,  making  it  support  a 
larger  superstructure  of  circulating  credit  and 
thereby  permanently  raising  the  world's  gold- 
standard  price  level.  Considerable  contraction 
may  occur  through  the  debasement  of  mone- 
tary units  in  bankrupt  countries. 

Deflation  may  be  aided  by  a  vigorous  dis- 
count policy  on  the  part  of  federal  reserve 
banks,  that  will  take  "the  market  out  of  bank" 
by  keeping  the  federal  reserve  bank  rates  well 
above  the  market  rates.  To  an  increasing 
degree  the  federal  reserve  banks  and  commer- 
cial banks  should  discriminate,  in  making 
advances,  in  favor  of  short-time  self-liquidat- 
ing commercial  paper,  and  against  war  debt 
paper  and  loans  that  directly  or  indirectly  pro- 
vide funds  for  speculation. 

Finally,  we  should  preach  and  live  the 
slogan  "work,  save  and  pay  up." 


INDEX. 

American  Economic  Review,  cited,  3n;  7n. 

Annalist  index  numbers,  cited,  35. 

Bank  deposits,  growth  of,  since  1913,  27;  increase  of,  an 
important  cause  of  inflation,  27-28. 

Bank  of  England,  notes  of,  from  1797  to  1821,  an  example 
of  specific  depreciation,  4;  extent  of  depreciation  of, 
notes  of,  during  period  of  Napoleonic  Wars,  36;  re- 
serves of,  in  1914  and  1920;  discount  policy  of,  77-78. 

Bondholders,  how  affected  by  inflation,  43;  how  affected  by 
deflation,  58-61;   69-70. 

Bradstreet's  index  numbers,  cited,  35. 

Bureau  of  Labor  Statistics,  wholesale  price  index  num* 
bers  of,  35;  studies  of,  concerning  budgets  of  laboring 
men's  families,  47;  index  numbers  of,  for  retail  prices 
of  food,  46-47. 

Cost  of  living,  rise  of,  since  1913,  47.    See  also  Prices. 

Creditors,  how  affected  by  inflation,  41-45;  how  affected  by 
deflation,  58-61;  69-70. 

Debasement  of  legal  gold  monetary  unit,  possible  in  certain 
belligerent  European  countries,  72;  arguments  that 
may  be  advanced  in  support  of,  72-75. 

Debtors  and  creditors,  how  affected  by  inflation,  41-45;  how 
affected  by  deflation,  58-61;  69-70. 

Debts,  outstanding  since  pre-war  times,  relation  of,  to 
deflation,  69-70.    See  also  Debtors  and  Creditors. 

Deflation,  evils  connected  with,  enumerated,  58;  evil  re- 
sults of,  to  debtor  classes,  59-61;  and  government  war 
debt,  60-61;  will  be  unpopular,  61;  temporarily  de- 
presses business,  61;  causes  unemployment  and  tends 
to  depress  wages,  62-63;  necessary,  because  of  in- 
adequacy of  gold  supply  to  support  present  structure 
of  circulating  credit,  63-69;  if  started  early  might 
eliminate  or  mitigate  some  evils  of  inflation,  69-70; 
to  pre-war  price  level  not  necessary,  71-75;  how  to  be 
brought  about,  75-82;  would  be  helped  by  high  federal 
reserve  discount  rates,  76-77;  would  be  helped  by  dis- 
count rates  discriminating  in  favor  of  short-time  self- 
liquidating  paper,  77;  would  be  furthered  by  govern- 
ment's living  within  its  income,  80. 

(83) 


84 

Demand  and  supply,  law  of,  in  its  relation  to  prices,  4-6; 
33-34. 

Deposit  credit,  forces  encouraging  expansion  of,  enu- 
merated, 18;  expansion  of,  profitable  to  banks,  18-21; 
expansion  of,  encouraged  by  Europe's  heavy  demands 
for  our  products,  21;  expansion  of,  appeared  to  bank- 
ers to  be  a  patriotic  duty  during  war,  22;  borrowing 
resulting  in  expansion  of,  appeared  to  public  to  be  a 
patriotic  duty,  22-23;  expansion  of,  encouraged  by 
low  discount  rate  policy  of  federal  reserve  authorities, 
22-25. 

Deposit  currency,  growth  of,  during  war  period,  27;  rate 
of  turnover  of,  increased  during  war  period,  28.  See 
also  Deposit  credit. 

Depreciation  of  money,  specific,  defined,  4;  general,  de- 
fined, 4-5. 

Depreciation  of  U.  S.  gold  dollar  from  1913  to  1920,  35; 
compared  with  that  of  Bank  of  England  notes  during 
Napoleonic  Wars,  36;  with  that  of  greenbacks  during 
Civil  War,  36. 

Discount  rates,  policy  of  federal  reserve  authorities  of 
keeping  low,  an  important  factor  In  inflation,  22-24; 
should  be  kept  higher  by  federal  reserve  banks  than 
market  rates  as  a  means  to  deflation,  76-77. 

Dun's  price  index  numbers,  dited,  35. 

European  public  debt,  not  a  desirable  investment  for  our 
commercial  banks,  80-81. 

Federal  reserve  banks,  loans  of,  to  member  banks  should 
be  only  for  temporary  and  emergency  needs,  76-77; 
should  discriminate  in  making  loans  and  rediscounts 
against  banks  lending  heavily  in  the  speculative 
market,  against  banks  extending  credit  unduly  for 
the  production  of  luxuries,  and  against  banks  whose 
borrowings  are  disproportionately  large  in  comparison 
with  their  capital  funds,  79;  tax  on  deficiency  reserves 
of,  should  be  enforced,  79-80, 

Federal  Reserve  Bulletin,  cited,  7. 

Federal  reserve  notes,  circulation  of,  14;  gold  reserves 
against,  14. 

Federal  reserve  system,  economics  in  the  use  of  gold, 
effected  by,  71-73.    See  also  Federal  reserve  banks. 

Garrett,  P.  W.,  cited,  38n. 


85 

Gold,  hea'vy  imports  of,  during  early  years  of  war,  a  cause 
of  Inflation,  13;  impounding  of,  by  federal  reserve 
banks,  13;  circulation  of,  discouraged,  26;  embargo 
laid  on  export  of,  26;  percentage  of,  in  total  monetary 
circulation  of  U.  S.  declines,  28-29;  amount  of,  in 
monetary  uses  in  U.  S.,  prior  to  war  and  now,  67-69; 
smaller  percentage  reserves  of,  needed  than  formerly, 
71-72.     See  also  Reserves. 

Government  debt,  how  related  to  inflation,  23-24;  should 
be  forced  out  of  commercial  banks  as  rapidly  as  pos- 
sible, 77-78;  question  of  refunding  at  a  higher  rate 
of  interest,  78-79. 

Government  expenditures,  economy  in,  needed  for  defla- 
tion,  80. 

Greenbacks,  an  example  of  specific  depreciation,  4;  extent 
of  depreciation  of,  during  Civil  War  as  compared  with 
depreciation  of  gold  aollar  during  Great  "War,  37. 

Inflation,  defined,  3;  forces  contributing  to,  12-18;  caused 
by  low  federal  reserve  discount  rates,  22-25;  effects 
of,  on  debtors  and  creditors,  41-45;  on  savings  de- 
posits, 42;  on  life  insurance  policies,  42;  a  tremendous 
engine  of  wealth  redistribution,  41-44;  53;  an  im- 
portant cause  of  widespread  public  discontent,  51-52; 
distributed  the  war's  financial  burden  inequitably, 
52-53;  affects  different  kinds  of  prices  and  the  prices 
of  different  kinds  of  goods  differently,  45-47.  See  also 
Prices  and  Deflation. 

Index  numbers  of  prices  in  U.  S.,  34-35. 

Interest  rates,  kept  down  by  inflationary  forces  that 
pushed  prices  up,  22-25.    See  also  Discount  rates. 

Mitchell,  W.  C,  cited,  9;   37;   46;    39. 

Monetary  circulation  of  U.  S.,  annual  amounts  and  index 
numbers  of,  12;    increased  71%  from  1913  to  1919,  12. 

"Money  in  circulation,"  defined  and  estimated,  10-12. 

Mutual  savings  banks,  long-time  securities  held  by,  in 
1918,  70n. 

Phelan  Act,  79. 

Physical  volume  of  business  for  years  1913  to  1919  meas- 
ured, fa-9. 

Price-fixing  by  Government,  38n. 

Prices,  individual  compared  with  general,  33-34;  of  many 
commodities  would  have  risen  during  war  even  with- 


out  inflation,  33-34;  extent  of  rise  of,  in  U.  S.,  since 
1913,  as  shown  by  index  numbers,  34-34;  advance  for 
nearly  all  classes  of  commodities  during  war  period, 
38-40;  high,  not  intrinsically  bad,  40-41;  rising,  have 
important  economic  results,  41;  wholesale,  retail,  and 
wages,  respond  differently  to  inflationary  forces,  45- 
51;  why  they  cannot  continue  at  present  level,  58; 
63-71;  rising,  artificially  stimulate  business  activity, 
61.     See  also  Wages. 

Public  debt,  its  relation  to  inflation,  23-24;  its  relation  to 
deflation,   60-61.     See  also  Government   debt. 

Public  utilities,  how  affected  by  inflation,  44;   47. 

Railroads,  how  affected  by  inflation,  44;  47. 

Reserves,  bank,  legal  requirements  concerning,  in  U.  S., 
greatly  reduced  between  1913  and  1919;  14-17;  re- 
duction of,  a  factor  in  inflation,  17;  against  deposits, 
decline  during  war  period,  28;  against  notes  and  de- 
posits, amount  of  needed,  63-64;  percentages  held 
against  notes  and  deposits  prior  to  war  and  since,  in 
EIngland,  in  Bank  of  France,  in  Germany,  in  Austro- 
Hungarian  Bank,  in  Russia,  in  Bank  of  Spain,  in 
Netherlands  Bank,  in  National  Bank  of  Switzerland, 
in  Bank  of  Norway,  in  Bank  of  Sweden,  in  U.  S.,  66-69. 

Savings  deposits,  how  affected  by  inflation,  42;  how 
affected  by  deflation,  69-70. 

Stockholders,  how  affected  by  inflation,  43. 

Wages,  how  affected  by  inflation,  47-51 ;  of  different  classes 
of  labor  affected  differently  by  inflation,  47-49. 

War  Industries  Board,  price  index  numbers  of,  35. 

War.     See  Inflation — Prices — Government  debt. 


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